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ISBN no. 978-1-869456-20-7

Project no. 14.20/16104

Public version

Input methodologies review – related party transactions

Final decision and determinations guidance

Date of publication: 21 December 2017

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Associated documents

Publication date Reference Title

21 December 2017 NZCC 30 Electricity Distribution Services Input Methodologies

Amendments Determination 2017

21 December 2017 NZCC 31 Gas Distribution Services Input Methodologies


21 December 2017 NZCC 32 Gas Transmission Services Input Methodologies


21 December 2017 NZCC 33 Electricity Distribution Information Disclosure


21 December 2017 NZCC 34 Gas Distribution Information Disclosure Amendments

Determination (No.2) 2017

21 December 2017 NZCC 35 Gas Transmission Information Disclosure

Amendments Determination (No.2) 2017

12 April 2017 978-1-869455-64-4

Input methodologies review – Related party

transactions – Invitation to contribute to problem

definition

14 September 2016 978-1-869455-36-1 Input methodologies review:

Process update paper

14 September 2016 Notice of intention Amended notice of intention: Input methodologies

review

20 December 2016 978-1-869455-44-6 Input methodologies review decisions:

Introduction and process paper


Framework for the IM review


Report on the IM review

16 June 2016 978-1-869455-17-0 Input methodologies review draft decisions: Topic

paper 7 – Related party transactions

1 October 2012 978-7-869452-09-4

Information Disclosure for Electricity Distribution

Businesses and Gas Pipeline Businesses: Final

Reasons Paper

16 January 2012 978-1-869451-87-5

Information Disclosure Requirements for Electricity

Distribution Businesses and Gas Pipeline Businesses

Draft Reasons Paper

22 December 2010 978-1-869451-32-5 Input Methodologies (Electricity Distribution and Gas

Pipeline Services) Reasons Paper

Commerce Commission

Wellington, New Zealand

3

Table of Contents

Executive Summary 5

What this paper covers 5

Our final decision 7

Our consultation with interested persons 9

Chapter 1 Introduction 11

Purpose of this paper 11

How this paper fits into the IM review and with ID amendments 11

Who this paper will be relevant to 13

Effective dates 14

Chapter 2 Related party transactions policy intent 16

Purpose of this chapter 16

The focus of this review 16

Our related party transactions provisions 17

Chapter 3 The problem definition 28


The problems identified 28

Chapter 4 Our amendments to the valuation methodology and key definitions 39


Our original approach 39

Our approach to developing the new valuation methodology 40

Details of our changes and our supporting reasoning 41

Chapter 5 Our amended related party disclosure requirements 68


Our related party disclosure requirements 68

Attachment A Guidance for the interpretation of paragraphs (a) and (b) of the related

party definition 85

Purpose of this attachment 85

Attachment B Indicative examples of arm’s-length and non-arm’s-length transactions 91


Attachment C Relationship between cost allocation rules and the related party

transactions provisions 95


Attachment D Incorporation of auditing and accounting standards by reference into

determinations 97


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Executive Summary

What this paper covers

X1 This paper sets out our final decision on our review of the related party transactions

provisions as part of the input methodologies (IMs) review which was largely

completed in December 2016.1 The IMs are the core rules we set when we regulate

services in the electricity distribution and gas distribution and transmission sectors.

X2 We have made changes to the IMs and have also decided to change the information

disclosure (ID) requirements for related party transactions to match these changes.

X3 Related party transactions occur when a supplier of services that we regulate, such

as an electricity lines business or a gas pipeline business, deals with an entity which

is related to it by a common shareholding or other common control.2

X4 We are concerned that consumers should not as a result of the related party

relationship be harmed by having to pay higher prices for the regulated service. For

example:

X4.1 Under the current rules, regulated electricity and gas businesses are able to

choose whether to competitively tender work out. As a result, regulated

businesses may be incentivised to give work, such as network maintenance

or tree trimming, to their unregulated related parties, even if an

independent contractor could offer a better price or service.

X4.2 Related party transactions could end up increasing the prices paid by

consumers for regulated services, as the use of an unregulated related party

to provide services may lead to higher input costs than if an independent

supplier had provided those services.

1 In September 2016 we decided to progress the review of the related party transactions provisions on a

longer timeframe than the rest of the IM review. This was to allow more time to assess whether the issues

identified in our June 2016 related party transactions topic paper amounted to a broader problem with

the related party transactions provisions. On 20 December 2016 we published our final decisions on all

other areas of the IM review except for three areas where we had not yet reached decisions. One of those

areas was the related party transactions provisions, which is the focus of this paper. 2 In this paper we refer to the supplier of a regulated service as the ‘regulated supplier’. However, using

that label does not preclude the supplier from also making unregulated supplies as well. This is

demonstrated in the examples in this paper.

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X4.3 Related party transactions and the lack of information on what the

equivalent arm’s-length terms would have been can make it difficult to

determine if cost efficiencies are being created in the regulated service, and

whether those benefits are being shared with consumers of the regulated

service or are just being enjoyed by the related party.

X4.4 Related party transactions may harm consumers of the regulated service if

the commercial relationship means quality is traded off in favour of other

interests of the related party supplying the service, or if the regulated

supplier uses a more costly input to deliver the regulated service without

any corresponding increase in quality.

X4.5 There can be less pressure from the commercial relationship to be

innovative, which can lead to higher costs or lower quality of service for

consumers.

X4.6 If the regulated supplier has the ability to require its consumers to use its

related party for services that are complementary to the regulated service,

consumers may end up paying more than efficient prices for those services

compared with if they were free to choose the supplier of the unregulated

service. In our view, providing greater transparency through ID in relation to

such requirements where they involve related parties of the regulated

supplier will promote the long-term benefit of consumers of regulated

services.

X5 We are not looking to prevent regulated suppliers from using related parties to

provide services, as they can be efficient, giving economies of scale and scope. But

there is an onus on a regulated supplier to show that the cost of the underlying

service is consistent with the input price that it would have otherwise paid in a

transaction on arm’s-length terms.

X6 In this paper we set out:

X6.1 our final decision on the review of the related party transaction provisions

for Electricity Distribution Businesses (EDBs) and Gas Pipeline Businesses

(GPBs); and

X6.2 our guidance to those regulated suppliers to help them apply the changes

to the IMs and ID determinations set out in the final decision.

7

X7 As this work is part of our 2016 IM review, we have applied our IM review

framework in our decision-making.3

Our final decision

Principles-based valuation approach

X8 Our final decision removes the original prescriptive valuation options for disclosing

the value of related party transactions. We concluded that those were not working

well.

Principles-based approach introduced

X9 We have introduced instead a principles-based approach where regulated suppliers

will need to show when dealing with a related party that the value of purchases and

sales is disclosed so that:

X9.1 each purchase is valued at no more than if it had the terms of an

independent arm’s-length transaction;

X9.2 a sale or supply to a related party is valued at no less than if it had the terms

of an arm’s-length transaction; and

X9.3 the value of any transaction is based on an objective and independent

measure.

X10 Consistent with the principles-based approach and to achieve a closer connection

with the accounting and auditing standards which are familiar to regulated suppliers,

we have adopted the wording for ‘arm’s-length transaction’ from the definition in

auditing standard ISA (NZ) 550.4

Testing of competitive markets and benchmarking of transaction values

X11 To meet the ‘objective and independent measure’ test, regulated suppliers will need

to disclose how they test competitive markets to value transactions for IM and ID

purposes, and be seen to apply that approach in practice.

3 Commerce Commission “Input methodologies review decisions: Framework for the IM review”

(20 December 2016). 4 External Reporting Board (XRB) “International standard on auditing (New Zealand) 550 - Related Parties

(ISA (NZ) 550).” Compiled November 2016 and incorporating amendments up to and including

October 2016, page 9.

8

X12 We decided to keep one of the original valuation options because it could be more

cost effective for suppliers, while still meeting our policy objective. Suppliers will be

able to use a consolidation (or cost-based) approach as a ‘safe-harbour’ for

demonstrating compliance with the above general valuation principle.

Where you can read more about the valuation approach

X13 Our decision on the general valuation approach is explained in Chapter 4 of this

paper.

New disclosure requirements to support the valuation approach

An updated role for the independent auditors

X14 Our decision to use general principles means there will be a closer connection to the

accounting and auditing standards applied by the auditors who will in future need to

give their opinion on the new valuation and disclosure requirements.

X15 The auditor’s annual ID assurance report will be required to state whether in the

auditor’s opinion the valuation and disclosure of related party transactions each

year, in all material respects, shows that it complies with the general related party

transactions valuation rule.

Our updated disclosure requirements

X16 We have included new disclosure requirements if a supplier of the regulated service

transacts with a related party in a disclosure year, including:

X16.1 disclosure of related party relationships;

X16.2 disclosure of the regulated supplier’s procurement policies and processes in

respect of a related party relationship;

X16.3 disclosure of policies which require or have the effect of requiring a

consumer to purchase unregulated services from a related party that is

related to the regulated service;

X16.4 details of how and when the regulated supplier last tested the market

valuation of transactions in at least one expenditure category; and

X16.5 a map of anticipated network expenditure and network constraints likely to

involve expenditure by the regulated supplier with related parties.

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Reduced disclosure requirements in some cases to make the cost and effort proportionate

X17 We have introduced a ‘de minimis’ threshold that limits the need for disclosure

requirements where suppliers have lower levels of total expenditure or a minimal

proportion of related party transactions. We think this will ensure that compliance

costs are proportionate to the size of the supplier and its level of related party

transactions.

X18 The ‘de minimis’ thresholds for limited disclosures apply where a supplier has:

X18.1 total annual expenditure of $20 million or less; or

X18.2 under 10% of total annual expenditure made up of related party

transactions.

More detailed reporting in other cases

X19 The supplier of the regulated service will be required to seek a further more detailed

report from the independent auditor or another qualified independent expert if:

X19.1 the related party transactions are 65% or more of a year’s total operating

expenditure (opex) or capital expenditure (capex) spend; or

X19.2 the independent auditor is not able to conclude that the valuation or

disclosures of related party transactions complies with the related party

rules.

X20 That regulated supplier will be required to obtain and disclose this independent

report in any year if:

X20.1 there was no report published for one of the immediately prior two years;

and

X20.2 the total value of related party transactions in each of the opex or capex

categories has increased by more than 5% for any year since the year

looked at in the last report.

Where you can read more about the new disclosure requirements

X21 Our decision on the new disclosure requirements is explained in Chapter 5 of this

paper.

Our consultation with interested persons

X22 We have had constructive engagement with a broad range of interested persons

over the course of our decision making. We appreciate the time and effort all parties

have taken to provide us with their submissions.

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X23 In particular, we received 18 submissions and 10 cross-submissions on our draft

decision which we published in August 2017. The key topics raised in those

submissions included:

X23.1 support for the principles-based approach;

X23.2 ambiguity around paragraph (b) of the ‘related party’ definition;

X23.3 the suggestion for the ‘de minimis’ threshold in response to concerns of

disproportionate compliance costs; and

X23.4 the suggestion to retain the consolidation (or cost-based) approach to

valuation.

X24 Our final decision is generally consistent with our draft decision. In response to the

submissions, we made the following key changes to our draft decision:

X24.1 We retained from the original requirements set in 2012 the consolidation

(or cost-based) approach to valuation. We had not included this in our draft

decision.

X24.2 We reduced the prescriptiveness of the disclosure requirements in the

ID determination to reduce unnecessary compliance costs.

X24.3 We introduced the ‘de minimis’ threshold to allow regulated suppliers with

small absolute or relative levels of related party expenditure to have less

onerous disclosure requirements.

X25 We also considered the suggestion proposed in submissions to take out part of the

definition of ‘related party’ to line it up more closely with the related party definition

in the accounting standards. However, we decided to keep paragraph (b) of the

definition, as we consider that its removal would have left a gap in the regime in

respect of unregulated services and would have put at risk the policy intent of the

related party rules.

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Chapter 1 Introduction

Purpose of this paper

This paper provides: 1.1

1.1.1 an outline of our policy intent for the related party transactions provisions

(Chapter 2);

1.1.2 confirmation of our problem definition for the input methodologies (IMs)

and information disclosure (ID) (Chapter 3);

1.1.3 an overview of our amendments to the related party transactions

valuation methodology and changes to key definitions (Chapter 4);

1.1.4 an outline of our amendments to the disclosure requirements for

electricity distribution businesses (EDBs), gas distribution businesses

(GDBs) and the gas transmission business (GTB) (Chapter 5);

1.1.5 guidance on the interpretation of the two paragraphs of the ‘related party’

definition (Attachment A);

1.1.6 indicative examples of transactions on arm’s-length and non-arm’s-length

terms (Attachment B);

1.1.7 an outline of the relationship between the cost allocation provisions and

related party transactions provisions (Attachment C); and

1.1.8 how we have incorporated elements of the auditing and accounting

standards into the determinations by reference (Attachment D).

How this paper fits into the IM review and with ID amendments

We first put the related party transactions provisions in place in 2010 for the IMs 1.2

and 2012 for ID provisions. We have now reviewed these as part of our IM review

process which commenced in mid-2015. The related ID requirements for related

party transactions were first determined in 2012.

12

In June 2016 we published a related party transaction topic paper as part of our 1.3

draft decisions package for the IM review. We set out why we considered it useful

for our review to simultaneously consider with the IMs whether changes to the

associated related party transactions ID requirements were required.5

In September 2016 we decided to progress the review of the related party 1.4

transactions provisions on a longer timeframe than the rest of the IM review.6 This

was to allow more time to assess whether the issues identified in our June 2016

related party transactions topic paper amounted to a broader problem with the

related party transactions provisions.7

On 20 December 2016 we published our final decisions on all areas of the 1.5

IM review except for the three areas where we had not yet reached decisions. One

of those areas was the related party transactions provisions, which is now the focus

of this paper.8 As this work remains part of the IM review, we have applied our IM

review framework for decision making.9

In early 2017 we met with a broad selection of regulated suppliers and 1.6

representatives of various auditing firms providing assurance reports in the

regulated sectors. The purpose of these meetings was to assess the extent to which

the related party transactions regime meets the policy intent of the related party

provisions and to gain a better understanding of a range of practical matters

relevant to the regime.

5 We note any changes to the ID requirements are consulted on and made under s 52Q of the Act, rather

than under s 52Y. Our topic paper indicated that we would review our related party provisions across ID

and the IMs in parallel. See Commerce Commission “Input methodologies review draft decisions: Topic

paper 7 – Related party transactions” (16 June 2016). 6 Commerce Commission “Input methodologies review: Process update paper” (14 September 2016);

Commerce Commission “Amended notice of intention: Input methodologies review”

(14 September 2016). 7 Commerce Commission “Input methodologies review draft decisions: Topic paper 7 – Related party

transactions” (16 June 2016). 8 Our final IM review decisions can be found in: Commerce Commission “Input methodologies review

decisions: Summary paper” (20 December 2016). We have since reached our decision on the Transpower

Incremental Rolling Incentive Scheme (IRIS) as part of the Transpower IM. We are yet to reach a decision

on our review of the IMs relating to CPP information requirements for gas. See: Commerce Commission

“Input methodologies review decisions: Introduction and process paper” (20 December 2016). 9 Commerce Commission “Input methodologies review decisions: Framework for the IM review”

(20 December 2016).

13

In April 2017 we published our problem definition paper which presented our initial 1.7

findings and emerging views on the problems with the original related party

transactions IMs and ID provisions. We sought submissions on this paper which

informed our draft decisions. Chapters 2 and 3 of this paper are based on the

problem definition paper and updated where appropriate in response to those

submissions.

On 30 August 2017 we published our draft decision paper. We received a large 1.8

number of substantive submissions and cross-submissions on the paper, including a

specific audit submission from PwC. We additionally took the opportunity to

discuss concepts and drafting with the Office of the Auditor General (OAG) as the

appointer of a number of auditors in the EDB sector. We considered these views in

coming to our final decisions presented in this paper.

This paper provides the reasons for our IM and ID decisions, and provides guidance 1.9

to support your use of the IM and ID amendments determinations.10

Our published documents

Our EDB, GDB and GTB ID determinations also include amendments made as part 1.10

of a separate project which has been published on the same date.11

Who this paper will be relevant to

The related party transactions provisions discussed in this paper apply to EDBs, 1.11

GDBs and the First Gas GTB.

This paper may also be of interest to: 1.12

1.12.1 entities involved in (or planning to be involved in) related party

transactions with EDBs, GDBs, or the GTB;

1.12.2 entities other than related parties that are involved in (or planning to be

involved in) transactions to provide services or assets to EDBs, GDBs, or

the GTB;

1.12.3 auditors completing compliance engagements on annual ID requirements

of the regulated suppliers;

10 To help you navigate from the requirements in the determinations to the reasons and explanatory

material in this paper, we have inserted guidance notes into the determinations for key amended clauses

and definitions, which we expect to stay in the final determinations. 11

These changes are described in: Commerce Commission “Amendments to information disclosure

determinations for airport services, electricity distribution services, and gas pipeline services: Companion

paper” (21 December 2017).

14

1.12.4 other gas and electricity sector firms, such as generator-retailers; and

1.12.5 consumers of electricity lines services and gas pipeline services.

Effective dates

Price-quality paths

The IM amendments take effect from the date of publication in the NZ Gazette 1.13

(ie, from 22 December 2017). This means:

1.13.1 the IM amendments apply to any customised price-quality path (CPP)

proposal submitted to us from 22 December 2017; and

1.13.2 the IM amendments will apply to default price-quality paths (DPPs) when

they are next reset in 2020 and 2022.12

Information disclosure

The IM and ID amendments take effect for ID disclosure years that commence after 1.14

the amendments are published. The EDB disclosure year 2019 commences on 1

April 2018. The GDB disclosure year 2019 commences on 1 June 2018 or 1 October

2018 depending on the GDB. The GTB disclosure year 2019 commences on

1 October 2018.

In particular, the EDB IM and ID amendments will apply to disclosed information 1.15

that we may use in determining the EDB 2020 DPP reset. Our objective is to ensure

that at least one year of updated disclosures is available to us for reference in

determining that reset.

Some submissions on our draft decision suggested a phased implementation for 1.16

the application of the new related party rules.13 Our final decision is to not change

the implementation timeframe outlined in our draft decision. We consider that the

simplification of the related party rules in our final decision removes the need for

delayed implementation of the rules.

12 The next EDB DPP reset is scheduled to take effect from 1 April 2020 and the GDB and GTB 2022 DPP

resets are scheduled to take effect from 1 October 2022. 13

For example, Aurora Energy “Submission: Related party transactions: Draft decision and determinations

guidance” (27 September), page 4.

15

Education on our related party rules

We intend to hold EDB ID workshop sessions with EDBs and auditors in April 2018 1.17

to assist those in the EDB regulation teams and their auditors to plan for the new

disclosures, depending on the level of disclosures required under our new

requirements.14

We intend to engage directly with First Gas and other GDBs on the implementation 1.18

of the new rules in April 2018 (for the 2018-2019 disclosures).

We consider that April 2018 is timely for the education sessions as this is the time 1.19

from which the new rules will apply to EDBs. We consider that the sessions will:

1.19.1 help regulated suppliers prepare for what information they need to collect

under our new requirements; and

1.19.2 explain our expectations of auditors for their opinions on regulated

suppliers’ compliance with our new requirements.

We will be in contact in early 2018 inviting participation in the workshops. We 1.20

expect to review the first round of disclosures in late 2019 or early 2020.

14 The different levels of disclosures are described in Chapter 5 of this paper.

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Chapter 2 Related party transactions policy intent

Purpose of this chapter

This chapter describes: 2.1

2.1.1 the focus of this review;

2.1.2 the background on the related party transactions provisions;

2.1.3 the policy intent of the provisions;

2.1.4 how we used the IM review framework to review the policy intent of the

provisions; and

2.1.5 our view that the policy intent remains relevant.

The focus of this review

Related party transactions occur when a regulated supplier transacts with an entity 2.2

which is related to it by a common shareholding or other common control. Those

transactions may not be on arm’s-length terms and the input costs of the regulated

supplier may not reflect efficient costs that we would expect might otherwise apply

in the absence of such a relationship.15

In this review we are interested in transactions where parties related to the 2.3

regulated supplier, or unregulated parts of the regulated supplier, are providing

inputs to the regulated supplier. The total volume and value of related party

transactions are proportionately large for regulated services (ie, electricity lines

services and gas pipeline services) and appear to be growing.16

The presence of related party transactions may not promote the Part 4 purpose. 2.4

Our concern is that suppliers of regulated services have the ability to use a related

party to:

2.4.1 increase overall profits by overcharging for inputs supplied by the related

party; and/or

15 In referring to ‘input costs’, we are referring to capex and/or opex costs to the regulated supplier.

16 The scale of related party transactions across EDB opex and capex can be seen in Figures 3.2 to 3.4 of

Commerce Commission “Related party transactions – Invitation to contribute to problem definition”

(12 April 2017). For the most recent disclosure data (year to 31 March 2017), refer to our performance

summaries for electricity distributors published on the Commission’s website:

http://www.comcom.govt.nz/dmsdocument/15808.

http://www.comcom.govt.nz/dmsdocument/15808

17

2.4.2 purchase services from a related party when it is not the most efficient

supplier.

We are concerned with ensuring that consumers of the regulated service should 2.5

not be harmed by having to pay higher prices for the regulated service as a result of

either of these two causes.

There may be an incentive for the regulated supplier to use an unregulated related 2.6

party to supply inputs at increased prices (and higher overall profits to the group).

Also, we are concerned that a supplier of a regulated service may be incentivised to 2.7

use a related party for an input to the regulated service even though it may not be

the most efficient provider of the input. Further detail of the potential risks of

related party transactions in achieving our regulatory objectives are outlined in

Table 2.1.

Although our related party provisions cover sales from the regulated supplier to the 2.8

related party, we consider these transactions are much less common and are less

material than the opex and capex inputs from the related party to the regulated

supplier, and are not a major focus area of our review.17

If a regulated supplier sells assets, goods or services to a related party at prices 2.9

below arm’s-length, consumers of the regulated service will essentially be

subsidising supply to the related party.18 This can increase profits to the related

party through charging consumers of the regulated service.

For completeness, these sales provisions have been considered as part of our 2.10

review.

Our related party transactions provisions

We regulate related party transactions through both our IM and our ID rules. Part 2 2.11

of each of the sector IM determinations applies related party transaction rules to

capex which is included in the value of commissioned assets that enters the

regulatory asset base (RAB) for the purposes of both ID and price-quality paths.19

17 In the 2016 disclosures, sales total $2 million across all EDBs, which is less than 1% of total regulatory

income. 18

The related party will be procuring these services from the regulated supplier at a lower cost than we

would expect from a transaction between two independent parties acting in their own best interests. 19

Electricity Distribution Services Input Methodologies Amendments Determination 2017 [2017] NZCC 30,

clause 2.2.11(1)(g); Gas Distribution Services Input Methodologies Amendments Determination 2017

[2017] NZCC 31, clause 2.2.11(1)(g); and Gas Transmission Services Input Methodologies Amendments

18

The ID determinations draw on the IM valuation rule for commissioned assets and 2.12

include valuation rules that cover the cost of services provided to a regulated

service by a related party. They also include valuation rules for the sale or supply of

an asset or good or service to a related party.20

The ID determinations include a requirement to provide a report on related party 2.13

transactions (ie, in respect of both capex and opex).21

Although we value opex under the ID provisions, we also take these values into 2.14

account in forming our conclusions on the opex allowances we use when setting a

price-quality path.

The common types of transactions covered by the related party provisions are: 2.15

2.15.1 IMs:22

2.15.1.1 the valuation of assets acquired from a related party.

2.15.2 ID:23

2.15.2.1 the valuation of services (all opex) acquired from a related

party; and

Determination 2017 [2017] NZCC 32, clause 2.2.11(1)(g). These provisions are set out in accordance with s

52T(1)(a)(ii) of the Act. 20

Electricity Distribution Information Disclosure Amendments Determination 2017 [2017] NZCC 33, clause

2.3.6; Gas Distribution Information Disclosure Amendments Determination (No.2) 2017 [2017] NZCC 34,

clause 2.3.6; and Gas Transmission Information Disclosure Amendments Determination (No.2) 2017 [2017]

NZCC 35, clause 2.3.6. 21


2.3.1 and Schedule 5b; Gas Distribution Information Disclosure Amendments Determination (No.2) 2017

[2017] NZCC 34, clause 2.3.1 and Schedule 5b; and Gas Transmission Information Disclosure Amendments

Determination (No.2) 2017 [2017] NZCC 35, clause 2.3.1 and Schedule 5b. These provisions are set out in

accordance with s 53C(2)(e) and (k) and s 53D of the Act. 22

The related party capex transaction valuation methodology is provided in Electricity Distribution Services

Input Methodologies Amendments Determination 2017 [2017] NZCC 30, clause 2.2.11(5); Gas Distribution

Services Input Methodologies Amendments Determination 2017 [2017] NZCC 31, clause 2.2.11(5); and Gas

Transmission Services Input Methodologies Amendments Determination 2017 [2017] NZCC 32, clause

2.2.11(5). 23

The related party opex and sales valuation methodology for EDBs is provided in Electricity Distribution

Information Disclosure Amendments Determination 2017 [2017] NZCC 33, clause 2.3.6; Gas Distribution

Information Disclosure Amendments Determination (No.2) 2017 [2017] NZCC 34, clause 2.3.6; and Gas

Transmission Information Disclosure Amendments Determination (No.2) 2017 [2017] NZCC 35, clause

2.3.6.

19

2.15.2.2 the valuation of sales to (and revenue received from) a related

party.

Our related party provisions provide valuation methodologies that are intended to 2.16

ensure transactions between a related party and a supplier of regulated services

are recognised for regulatory purposes at values that are equivalent to arm’s-

length terms.

These provisions consider the valuation and disclosure of opex or capex inputs from 2.17

a related party to the supplier of the regulated service, and sales to a related party

by the supplier of the regulated service.

As a practical matter, we are not permitted to integrate all of the valuation 2.18

requirements into the IMs, as there is no existing opex input methodology. We

cannot create an IM on a matter not covered by an existing IM under s 52Y or s 52X

of the Act, which is why we do not have an IM for opex and cannot now determine

one.

The IMs set out the rules for the valuation of assets and capex, and our rules for the 2.19

valuation of opex and sales transactions are set out in the ID requirements.24

Why we regulate related party transactions

The purpose of Part 4 of the Act is outlined as:25 2.20

The purpose of this Part is to promote the long-term benefit of consumers in markets

by promoting outcomes that are consistent with outcomes produced in competitive

markets such that suppliers of regulated goods or services—

(a) have incentives to innovate and to invest, including in replacement, upgraded, and

new assets; and

(b) have incentives to improve efficiency and provide services at a quality that reflects

consumer demands; and

(c) share with consumers the benefits of efficiency gains in the supply of the regulated

goods or services, including through lower prices; and

(d) are limited in their ability to extract excessive profits.

24 See Commerce Commission “Input methodologies review decisions: Framework for the IM review”

(20 December 2016), para 47. 25

As set out in s 52A of the Act.

20

Potential outcomes and risks of related party transactions with respect to the Part 4

purpose

We consider that transactions between related parties have the potential to impact 2.21

the achievement of the Part 4 purpose.26

Table 2.1 sets out the relevant regulatory objectives under Part 4 and considers the 2.22

outcomes and risks that related party transactions can have for the achievement of

these objectives.27

When suppliers are selling their goods or services in competitive markets, the price 2.23

they charge reflects the interplay between demand and supply from a range of

other parties. In this context, a consumer does not typically care what costs the

supplier incurs and why, nor do they care whether the supplier has used related

party relationships to produce its service.

This is because the consumer has choices over what to buy and from whom, and 2.24

can switch products or suppliers if they find a better offer. One supplier attempting

to pass on costs specific to it (not borne to the same extent by other suppliers) can

expect to lose market share, and potentially profits, as consumers may prefer other

suppliers’ offers.

In contrast, a supplier of a regulated service has market power and, in the absence 2.25

of regulation, would charge a price that reflects that market power. The regulatory

price for their services is determined largely by the costs they incur.

For example, as a starting point under our price-quality regulation we assume the 2.26

costs that regulated suppliers incur reflect efficient costs, and we use estimates of

actual and forecast costs to inform allowed prices. Exempt suppliers may also use

their actual or budgeted costs to determine prices for their services.

When referring to efficient costs we mean the prudent costs that a supplier of the 2.27

regulated service would require to meet or manage expected demand for its

services, at appropriate service standards.

In the regulated context, we and consumers therefore care about whether the 2.28

underlying costs incurred in setting prices are efficient, and in particular whether

the cost paid for a service from a related party is efficient, because it may directly

impact on the price that consumers ultimately pay.

26 As set out in s 52(a)(1(a)–(d)) of the Act.

27 We also consider the s 53A ID purpose in our review of the related party provisions further on in this

chapter.

21

We do not seek to prevent regulated suppliers from using related parties to provide 2.29

services as they can be efficient, securing economies of scale and scope. However,

there is an onus on the regulated supplier to be able to demonstrate that the cost

of the underlying service is efficient and consistent with the input price that it

would have paid in an arm’s-length transaction.

22

Table 2.1 Risks to regulatory objectives posed by related party transactions

Regulatory

objective Intended outcome Potential risks of related party transactions

Efficiency28

Suppliers of regulated services should have incentives to improve

efficiency in the supply of the regulated goods or services and

share the benefits of efficiency gains with consumers through

lower prices.

Close business relationships (including related party relationships) may generate

economies of scale and scope that could benefit consumers. However, the presence of

related party transactions, coupled with the lack of information on what equivalent

arm’s-length terms would have been, can make it hard to determine:

if cost efficiencies (or inefficiencies) are being created; and

whether any efficiencies are being shared with consumers of the

regulated service; or

whether a related party has chosen the most efficient supplier and

hence whether any inefficiencies are affecting input costs.

Our related party transactions provisions seek to ensure such efficiencies are shared

with consumers.

28 When referring to efficiency of related party transactions, we are referring to cost efficiencies in providing services at a quality that reflects consumer demands and the

sharing with consumers of the benefits of efficiency gains in the supply of the regulated goods or services, including through lower prices: see s 52A of the Act.

23

Regulatory

objective Intended outcome Potential risks of related party transactions

Profits Suppliers of regulated services should expect profits are just

sufficient to reward investment, efficiency and innovation.

Superior performers are more likely to be rewarded by receiving

returns greater than a ‘normal profit’ (or ‘normal return’- ie, their

risk-adjusted cost of capital), at least for the short-to-medium

term, until competitors catch up. Over the lifetime of its assets, a

typically efficient supplier would not invest unless it expected, in

advance, to earn at least a normal return.

Due to the close business relationship between related parties, there is the potential

to increase overall profits by overcharging for inputs supplied by the related party.

This could adversely affect the consumer of the regulated service through higher

prices, which is a key consideration in our review.

Price The price paid by consumers should be based on efficient input

costs. In workably competitive markets, suppliers have incentives

to constrain price.

The presence of related party transactions may adversely affect the ability to constrain

prices to the benefit of consumers, as there may be an ability to use an unregulated

related party to increase overall profits. This is a key consideration in our review.

Quality Suppliers of regulated services should have incentives to improve

efficiency and provide services at a quality that reflects consumer

demands.

The presence of related party transactions may adversely affect quality of service

provided to consumers of the regulated service if the relationship means quality is

traded off in favour of other interests of the party supplying the service. This issue is

not a primary driver of the related party provisions across the IM and ID

determinations.

Investment Suppliers of regulated services should have incentives to

undertake investments at an efficient level at the optimal time (to

the extent these levels and time can be ascertained).

The presence of a related party relationship and extensive related party transactions

could affect the level and timing of investment. For example, if weight is placed on the

interests of the related party supplying the service, more investment may be

undertaken or more opex incurred, and at greater cost, than if the relationship and all

transactions were on arm’s-length terms.

Innovation Suppliers of regulated services should have incentives to promote

the discovery and use of new information, leading to the

development of new goods and/or services, and more efficient

production techniques.

Given related parties are not independent and have an ongoing close operating

nature, there can be reduced pressure from the commercial relationship to be

innovative.

24

Relationship between cost allocation and the related party transactions provisions

The cost allocation rules split shared costs between regulated and unregulated 2.30

activities for regulatory purposes. For example, common operating costs (eg,

expenses for a head office) and commonly used assets (eg, poles which carry both

electricity and fibre) have their costs shared between regulated and unregulated

services.29

Sharing of services can produce cost efficiencies. A purpose of cost allocation is to 2.31

ensure these efficiencies are effectively shared with consumers. The cost allocation

provisions look at the splitting of shared costs between unregulated and regulated

activities.

However, the cost allocation provisions do not address: 2.32

2.32.1 the value placed on services supplied by a related party; or

2.32.2 the value of revenues from sales to a related party.

These are dealt with in the related party transactions provisions to ensure such 2.33

transactions are valued on terms that are equivalent to arm’s-length. For example,

when considering an internal part supplying unregulated services within a

regulated supplier. The related party rules assess the valuation of goods and

services provided by the internal part or related separate legal entities.

We provide a diagram in Attachment C that shows how and when to value a 2.34

transaction with a related party that has a cost allocation requirement.

29 Cost allocation rules for ID are found in: Electricity Distribution Services Input Methodologies

Determination 2012 – (consolidated as of 28 February 2017), Part 2 Subpart 1; Gas Distribution Services

Input Methodologies Determination 2012 – (consolidated as of 28 February 2017), Part 2, Subpart 1; and

Gas Transmission Services Input Methodologies Determination 2012 – (consolidated as of 28 February

2017), Part 2, Subpart 1. Cost allocation rules for CPP proposals are found in: Electricity Distribution

Services Input Methodologies Determination 2012 – (consolidated as of 28 February 2017), Part 5, Subpart

3; Gas Distribution Services Input Methodologies Determination 2012 – (consolidated as of 28 February

2017), Part 5, Subpart 3; and Gas Transmission Services Input Methodologies Determination 2012 –

(consolidated as of 28 February 2017), Part 5, Subpart 3.

25

Review of the policy intent of the related party transactions provisions

Consistent with the IM review framework, in reviewing the related party 2.35

transactions provisions we considered whether the policy intent was still relevant,

and whether the way the provisions have been implemented could be more

effective in achieving that policy intent, or achieve it in a way that better promotes

s 52R or reduces complexity and compliance costs.30

In deciding whether to make changes to the provisions as a result of this review, we 2.36

are guided by the IM review framework. Specifically, we only propose changing the

related party transactions provisions across the IMs and ID where this appears

likely to:

2.36.1 promote the Part 4 purpose in s 52A more effectively;

2.36.2 promote the IM purpose in s 52R more effectively (without detrimentally

affecting the promotion of the s 52A purpose); or

2.36.3 significantly reduce compliance costs, other regulatory costs or complexity

(without detrimentally affecting the promotion of the s 52A purpose).

We also considered the s 53A ID purpose to the extent we have considered changes 2.37

to the ID requirements:31

The purpose of information disclosure regulation is to ensure that sufficient

information is readily available to interested persons to assess whether the purpose of

this Part (Part 4) is being met.

We also considered, where relevant, whether there were alternative solutions to 2.38

the identified problems with the IMs and ID that do not involve changing the IMs.

Whether the policy intent of the related party transactions provisions is still relevant

We have expressed the policy intent in various documents over time as 2.39

summarised below. The words used in each instance are not exactly the same, but

the key principles from our documents are.

30 This is set out in more detail in: Commerce Commission “Input methodologies review decisions:

Framework for the IM review” (20 December 2016). 31

See s 53A of the Act.

26

Our concern is that suppliers of regulated services have the ability to use an 2.40

unregulated related party to:

2.40.1 increase overall profits to the overall group by overcharging for inputs

supplied by the related party to the regulated service; and/or

2.40.2 purchase services from a related party when it is not the most efficient

supplier.

Inputs into the regulated service may in either of those cases end up being over-2.41

priced, which would not promote the long-term benefit of consumers.

Our policy intent is therefore to ensure that the value of a good or service acquired 2.42

by the regulated supplier from a related party, or the value received from the sale

or supply by the regulated supplier of an asset or good or service to a related party,

is disclosed on the basis that:

2.42.1 each related party transaction is valued as if it had the terms of an arm’s-

length transaction; and

2.42.2 the value of a related party transaction is based on an objective and

independent measure.

What we said in 2010 in the development of the input methodologies

In our 2010 paper, the intention behind the development of our related party 2.43

transaction provisions in the IMs was:32

Without the discipline of arm’s-length negotiation, which is essentially where the price

paid for an asset may be greater (or less) than an asset’s market value, there could be

a transfer of value between an EDB or GPB and consumers that would not otherwise

occur. To address this concern, the Commission considers that where a regulated

supplier buys an asset from a related party, the asset’s RAB value should not be based

on the purchase price, but instead on some objective, independent measure.

What we said in 2012 when putting in place the information disclosure requirements

In our 2012 paper, our intention behind the related party transactions ID 2.44

requirements was to enable interested persons to understand whether the

information disclosed may be affected by related party dealings.

32 Commerce Commission “Input Methodologies (Electricity Distribution and Gas Pipeline Services) Reasons

Paper” December 2010, E8.8–E8.9.

27

In setting ID requirements we considered the value placed on services supplied by 2.45

related parties and revenues received from related parties. The policy intent in our

ID determinations is similar to that of the IMs. ID also requires the value of related

party transactions to be based on, or linked to, objective verifiable information.

This information should help demonstrate that the price approximates that which

could be expected in a transaction on arm’s-length terms.33

We concluded in 2012 that the related party transactions provisions in ID should 2.46

allow interested persons to have access to information that discloses:

2.46.1 the existence and extent of related party transactions;

2.46.2 what the related party transactions relate to;

2.46.3 whether the price is the same or similar to the price which would be

expected in an equivalent arm’s-length transaction (and if not, what

adjustment is required to make it similar to an arm’s length price); and

2.46.4 whether the price is based on objective verifiable information.

Continued policy relevance

We consider the policy intent of the related party transactions provisions is still 2.47

relevant for both the IMs and ID. We have seen nothing in our review which

suggests that the policy intent for these provisions should change.

Submissions on our problem definition paper generally agreed with our policy 2.48

intent to ensure that transactions between related parties and suppliers of

regulated services are equivalent to arm’s-length terms.34

33 Commerce Commission “Information Disclosure Requirements for Electricity Distribution Businesses and

Gas Pipeline Businesses Draft Reasons Paper” (16 January 2012), A1.36. 34

For example, see Pioneer Energy “Pioneer Energy submission - Related party transactions - problem

definition” (17 May 2017), page 1; and ENA “ENA Submission on IM review - Related party problem

definition” (17 May 2017), page 4.

28

Chapter 3 The problem definition


This chapter provides: 3.1

3.1.1 our response to relevant submissions on the problem definition; and

3.1.2 our confirmation of the problem definition.

The problems identified35

We identified the following broad problem with the original related party 3.2

provisions:36

3.2.1 The practical application of the related party provisions was not well

aligned with the policy intent.37

This can be further broken down into two problems with a common linked 3.3

potential harm to consumers of regulated services:

3.3.1 Aspects of the way we designed and implemented the related party

transactions rules raises a risk that we would not achieve the related party

transactions policy intent (problem one).

3.3.2 Aspects of the way in which some regulated suppliers applied the rules

also raised the risk that the related party transactions policy intent is not

being achieved in practice (problem two).

35 In April 2017 we published a problem definition paper outlining our initial findings and emerging views on

related party transactions regime. See Commerce Commission “Related party transactions – Invitation to

contribute to problem definition” (12 April 2017). 36

Electricity Distribution Services Input Methodologies Determination 2012 – (consolidated as of 28 February

2017); Gas Distribution Services Input Methodologies Determination 2012 – (consolidated as of 28

February 2017); Gas Transmission Services Input Methodologies Determination 2012 – (consolidated as of

28 February 2017); Electricity Distribution Information Disclosure Determination 2012 – (consolidated in

2015); Gas Distribution Information Disclosure Determination 2012 – (consolidated in 2015); and Gas

Transmission Information Disclosure Determination 2012 – (consolidated in 2015). Throughout this paper

we refer to these decisions as our ‘original’ decisions. 37


(12 April 2017), para 4.2.1.

29

We see our role as being to create rules that support regulated suppliers in meeting 3.4

the arm’s-length policy intent. Our related party transactions provisions are aimed

at requiring regulated suppliers and their related parties to demonstrate that for

regulatory purposes, the transactions between them are equivalent to arm’s-length

terms. To achieve this, our related party rules must be workable and applicable in a

wide range of supplier circumstances.

We have outlined the above problems based on our discussions with a sample of 3.5

EDBs and sector auditors, submissions received during the IM review, and

information gathered through our reviews of ID over time.

As a result of the two identified problems, the value at which an asset or service is 3.6

transferred from a related party to a regulated supplier may not be consistent with

an arm’s-length transaction. We wish to avoid this, as it could frustrate the

achievement of the Part 4 purpose.38

What we considered in reaching our view on the problem

In designing and implementing our original rules we provided a number of 3.7

valuation and disclosure options which may not be achieving our intended

outcomes. This is because we understand some of the prescriptive options we

originally designed may not be usable in a number of typical company ownership

and operating structures.

In understanding the two problems identified above, we have analysed the context 3.8

and issues under the following headings:

3.8.1 imperfect local markets consideration;39

3.8.2 complexity and understanding of terminology;

3.8.3 transparency of disclosures; and

3.8.4 compliance with the prescribed rules.

38 Chapter 2, Table 2.1 sets out the regulatory objectives consistent with Part 4 of the Act and considers the

outcomes and risks that related party transactions can have on the achievement of these objectives. 39

In smaller regional markets, EDBs may have fewer choices and face difficulties in attracting third party

contracting service companies and some specialist services to the area to get the services required. We

refer to this issue as imperfect local markets. An EDB example is not having electrical contracting services

readily available in the EDB location.

30

Table 3.1 and Table 3.2 provide explanations of the problems and our view of their 3.9

potential impact on consumers. These tables outline:

3.9.1 what we saw from our discussions with the sample of EDBs, auditors, and

in the ID reporting, and how this points to the problems;40

3.9.2 the effect the focus areas outlined in these tables is having on the

identified problems; and

3.9.3 our consideration of the materiality of the issues for consumers.

40 An overview of our initial findings can be found in Chapter 3 of our problem definition paper, see


(12 April 2017).

31

Table 3.1 Problem with the nature of our original design and implementation of the related party transactions provisions and potential

impact on consumers

Overarching

problem

Focus areas What are we seeing which points to this being a problem? Effect of the problem Materiality of potential

impact on consumers

Our design and

implementation

of the

provisions

Imperfect

local market

for

contracting

services

In our original decisions, we attempted to design a range of disclosure

options that would encompass most foreseeable circumstances such as an

imperfect local market for contracting services. Due to the lack of

comparative market information, there is a difficulty in measuring an

appropriate internal margin for contracting activities provided by an

integrated business unit of the regulated supplier or another company in the

group.

In particular, the provisions provide options for disclosing using a competitive

tender process, however only a small number of regulated suppliers disclose

using this option.

Valuation of transactions

affected in each case. This

could lead to transactions

not being equivalent to

arm’s-length terms, which

could adversely affect the

consumer.

Medium

Not all regulated

suppliers face an

imperfect local market

in assessing whether

transactions are on the

equivalent of arm’s-

length terms.

32

Overarching

problem


impact on consumers

Complexity of

terminology

Ambiguity is caused by:

the original rules use some terms that are not as well defined

as they could be; and

some terms used have more than one meaning within the

IMs and more broadly.

In particular, the term ‘directly attributable costs’ is used in the cost

allocation provisions to mean something different from the meaning

intended for related party transactions. A ‘related party’ is defined in

accounting standards but defined differently for the purposes of our

regulatory rules.41

Decreased quality of

disclosure and potential

impact on the valuation of

transactions.

High

This could have a large

impact on the valuing

of transactions.

41 In its submission, Vector noted that a clear definition about the term related party should mitigate the likelihood for selective interpretation. Vector “Vector

submission on related party transactions” (17 May 2017), para 22.

33

Overarching

problem


impact on consumers

Transparency

of our

methodology

The way in which the original valuation options are drafted can lead to some

regulated suppliers defaulting to the director certification option. This

provides stakeholders with limited transparency of information to assessing

whether the transactions are at the equivalent of arm’s-length terms.

A high proportion and value of transactions are being disclosed under this

low visibility option. This raises questions as to the appropriateness of the

methodology if directors are not applying the necessary rigour in providing

certification.

Decreased confidence in ID.

This makes it hard for us to

assess whether any

efficiencies are being shared

with consumers of the

regulated service if these

are being enjoyed by the

related party.

Medium

Some disclosure

valuation options result

in limited transparency.

We consider the

percentage of EDBs

using the director

certification option is

sufficiently material to

limit transparency of

the potential impact on

consumers.

Compliance

with the

prescribed

rules

The original rules are drafted in a way which has led to some confusion as to

which rules apply to opex and capex transactions due to the disconnection of

the IMs and ID.42

In particular, ID shows some suppliers of regulated services inappropriately

applying IM capex rules to opex or vice versa.

Decreased quality of

disclosure. Any inconsistent

disclosure decreases

transparency that

transactions are on arm’s-

length terms.

Low

Some suppliers are

showing confusion as

to what ID and IMs

cover.

42 A number of submissions on the problem definition paper noted the problem with the inconsistency across the IMs and ID, including PwC. PwC “PwC group submission

on related parties” (17 May 2017), page 10.

34

Table 3.2 Problem with the nature of regulated suppliers’ application of the original related party transactions provisions and potential

impact on consumers

Overarching

problem


impact on consumers

Regulated

suppliers’

application of

the provisions

Imperfect local

market in

contracting

services

We are seeing limited separation of governance between

management of the related party and the supplier of the

regulated service. This, combined with a lack of credible

benchmarking between the regulated supplier and its various

related parties in imperfect local markets, means there is less

likelihood that related party transactions will be

demonstrated to be on the equivalent of arm’s-length

terms.43

In particular, some behaviour shows procurement preference

for ‘in-house’ contracting services, which is also supported by

a submission.44

Valuation of transactions may be

affected. If the input prices paid by

the regulated supplier are too high,

this would not promote the long-

term benefit of consumers of the

regulated service.

Medium

This type of market is not

faced by all regulated

suppliers.

Complexity in

understanding

terminology

Due to the ambiguity of the key defined terms, suppliers have

made their own interpretations as to the defining of key terms

in the rules, such as directly attributable costs.


affected. This could lead to higher

input costs for the regulated

supplier, which would adversely

affect the long-term benefit for

consumers of the regulated service.

High

Due to potential impact

on the valuation of

transactions.

43 The ENA acknowledged that imperfect local markets are a characteristic of the sector, and that the Commission cannot solve this problem through related party

transaction rules. ENA “ENA Submission on IM review - Related party problem definition” (17 May 2017), para 21. We agree that the related-party transaction rules

cannot solve this problem, but it should be considered when assessing whether related party transactions meet arm’s-length terms. 44

Asplundh “Input Methodologies Review - draft decisions, topic 7: Related Party Transactions” (11 August 2016).

35

Overarching

problem


impact on consumers

Transparency of

the valuation of

transactions

Directors’ certification has effectively become a default option

to use in disclosing the valuation of related party transactions

for some regulated suppliers. This results in a lower level of

transparency that prices achieved are equivalent to arm’s-

length terms as there is no visibility in how directors have

satisfied that conclusion.45

In particular, we have seen increased values of related party

transactions using director certification in information

disclosures and limited or no use of some other valuation

options available. There does not seem to be consistent

reasoning from regulated suppliers as to the use of this

option.46

Decreased confidence in ID. This

makes it hard for us to assess

whether any efficiencies are being

shared with consumers of the

regulated service or if these are

being enjoyed by the related party.

Medium

Not all disclosure

valuation options provide

for limited transparency.

Compliance with

the prescribed

rules

The way in which the original rules were drafted has led to

some suppliers charging a margin in excess of the 17.2%,

which was intended to allow for the recovery of overhead

costs experienced by the related party. This is either by

charging a higher margin and using director certification or by

structuring their business in a way to receive a greater

combined margin.


affected. If prices charged by

related parties are too high, this

would adversely affect the

consumers of the regulated service.

Medium

Our focus is ensuring any

efficiency gains made

from the use of a related

party are passed through

to the consumer.

45 We acknowledge that the original related party provisions did not require such additional disclosure.

46 Our intention was for director certification to only be used when none of the other options apply. See Commerce Commission “Information Disclosure for EDBs and

GPBs Final Reasons Paper” (1 October 2012), para 3.50.

36

Submissions received on our problem definition paper

We concluded on balance that the submissions received confirmed our problem 3.10

definition and a number provided suggestions on how we could update the related

party transactions provisions to address the problem. We have taken these into

account in the solutions in Chapters 4 and 5.

We received a range of submissions on our problem definition paper, with some 3.11

submitters agreeing that there is a clear problem, and others considering the

problem to be overstated.

MEUG supported our interpretation of the problem definition, noting:47 3.12

The related party provisions are not leading to outcomes consistent with the purpose

of Part 4 of the Act relative to an alternative set of provisions.

Several submitters supported our problem definition that the policy intent could be 3.13

better implemented through a review of the original rules. For example, in its

submission, Powerco stated:48

Aspects of the current design are difficult to interpret and therefore implement. The

difficulties we have experienced appear to be common to suppliers as evidenced in the

Commission’s findings. We have found the complexity of the rules and inconsistency

between IMs and IDD (sic) particularly troublesome. We welcome a review of these

rules.

We have considered submissions on the complexity of the original regime in 3.14

devising our amendments outlined in Chapters 4 and 5.

Conversely, some submissions on our problem definition paper disagreed with our 3.15

problem definition, stating that the original provisions met the policy intent. For

example, Wellington Electricity Lines Limited (WELL) submitted:49

WELL considers that with the exception of some improvement to the design and

structure of the related party rules, the existing provisions in the input methodologies

and information disclosure requirements are working effectively to support this policy.

47 MEUG “MEUG to CC, Related Party Transactions” (17 May 2017), para 5.

48 Powerco “Powerco submission on problem definition” (17 May 2017), page 3.

49 Wellington Electricity Lines Limited “Wellington Electricity Lines Limited – IM submission – related party

transactions problem definition” (17 May 2017), page 1.

37

Based on our learnings from discussions with other suppliers of regulated services 3.16

in the EDB sector and our subsequent further analysis, we do not agree with WELL’s

comment.50 We instead agree with MEUG that the original provisions allowed for

outcomes that are not consistent with the Part 4 purpose, and we have considered

this in developing our amendments.

Several submissions were concerned that the Commission’s view of the degree of 3.17

the potential problem was overstated, citing a lack of evidence that regulated

suppliers are inherently biased towards related party transactions that do not meet

an arm’s-length standard. For example, Aurora stated in its submission on the

problem definition paper:51

We are yet to see evidence of related parties supplying inputs at excessive prices

under the current RPT rules. Aurora considers that evidence of over-payments is

needed to justify tightening of the RPT rules.

Given the fact that the total volume and value of related party transactions are 3.18

large and growing, we are concerned that the potential for consumer harm could

be significant.52 However, with the way the original prescriptive set of rules were

set out, it is correct that we were unable to conclude whether a large share of the

related party transactions met the arm’s-length standard.

Nova stated in its submission that the number of specific instances where the 3.19

original related parties regime was being abused was difficult to identify, given

that: 53

3.19.1 beneficiaries of such arrangements will not object;

3.19.2 inadequate disclosure requirements make it difficult for disadvantaged

competitors to establish evidence of non-arm’s-length practices; and

3.19.3 consumers that indirectly incur the costs have no real engagement.

50 Our discussions with suppliers of regulated services are set out in our problem definition paper.

51 Aurora “Aurora Submission - RPT Problem Definition” (17 May 2017), page 1. We note that Aurora made a

similar point in its submission on the draft decision paper: Aurora Energy “Submission: Related party

transactions: Draft decision and determinations guidance” (27 September), page 3. 52

The scale of related party transactions across EDB opex and capex can be seen in Figures 3.2 to 3.4 of


(12 April 2017). For the most recent disclosure data (year to 31 March 2017), refer to our performance

summaries for electricity distributors published on the Commission’s website:

http://www.comcom.govt.nz/dmsdocument/15808. 53

Nova “Nova submission IM review - Related Party Transactions” (17 May 2017), page 1.

http://www.comcom.govt.nz/dmsdocument/15808

38

Our view of the potential materiality of the problem is supported by the ERANZ 3.20

submission on the problem definition paper.54

Submissions on our problem definition paper proposed that many of the problems 3.21

in the regime could be resolved by replacing the complex and inconsistent

provisions with a principles-based approach.55

In particular, we have noted the submission points regarding the perceived degree 3.22

of the problem and have attempted to ensure that the approach we have adopted

to the general valuation rule and the specific ID requirements is scaled

appropriately for the issue.

54 ERANZ “ERANZ submission on Related Party Transactions Issues Paper” (17 May 2017), para 5.1.

55 For example, PwC “PwC group submission on related parties” (17 May 2017), para 7; ENA “ENA

submission on IM review - Related Party problem definition” (17 May 2017), para 11.

39

Chapter 4 Our amendments to the valuation

methodology and key definitions



4.1.1 an outline of our original approach;

4.1.2 our new principles-based valuation methodology;

4.1.3 our updated annual ID audit requirements amended to align with the new

valuation methodology; and

4.1.4 our amendments to key definitions to implement the new valuation

methodology.

Our original approach

Our original related party transactions provisions included prescriptive valuation 4.2

options. We required suppliers of regulated services to disclose related party

transactions using one of an identified list of options. We had:

4.2.1 nine valuation methodology options for capex supplied by related

parties;56

4.2.2 seven valuation methodology options for opex supplied by related

parties;57 and

4.2.3 three valuation methodology options for revenue received from related

parties.58

56 Electricity Distribution Services Input Methodologies Determination 2012 – (consolidated as of 28 February

2017), clause 2.2.11(5); Gas Distribution Services Input Methodologies Determination 2012 – (consolidated

as of 28 February 2017), clause 2.2.11(5); and Gas Transmission Services Input Methodologies

Determination 2012 – (consolidated as of 28 February 2017), clause 2.2.11(5). 57

Electricity Distribution Information Disclosure Determination 2012 – (consolidated in 2015), clause 2.3.6;

Gas Distribution Information Disclosure Determination 2012 – (consolidated in 2015), clause 2.3.6; and Gas

Transmission Information Disclosure Determination 2012 – (consolidated in 2015), clause 2.3.6. 58

Electricity Distribution Information Disclosure Determination 2012 – (consolidated in 2015), clause 2.3.7;

Gas Distribution Information Disclosure Determination 2012 – (consolidated in 2015), clause 2.3.7; and Gas

Transmission Information Disclosure Determination 2012 – (consolidated in 2015), clause 2.3.7.

40

The feedback we received from auditors and the submissions we received on our 4.3

problem definition consultation paper informed us that the rules of the prescriptive

valuation options could be difficult to interpret and apply in practice.59

We consider our original prescriptive valuation options could not be adequately re-4.4

written to:

4.4.1 ensure the related party policy intent was met; and

4.4.2 address comments provided in submissions on the ability to apply the

original rules in practice.

Our approach to developing the new valuation methodology

In assessing the best outcome for a new valuation methodology, we considered:60 4.5

4.5.1 the best way of ensuring that the policy intent would be achieved and the

Part 4 purpose would be promoted; 61

4.5.2 the need for clear alignment of related party provisions across the IMs and

ID provisions;

4.5.3 our understanding of the needs of the following stakeholders who will be

applying the provisions, so as to avoid future interpretation issues,

including:

4.5.3.1 regulatory accountants completing annual disclosure

documentation; and

4.5.3.2 sector auditors completing ID assurance engagements;62 and

59 Deloitte noted that the related party transactions rules are complex and it has had to resolve issues with

an audit client on the varying interpretations of the rules, particularly the classification and measurement

of related party transactions. Commerce Commission “Related party transactions – Invitation to

contribute to problem definition” (12 April 2017), para 3.23. PwC noted that a significant source of

complexity of the related party transactions rules is the level of prescription used in the original regime.

PwC “Submission to the Commerce Commission on Input Methodologies review: Related party

transactions – invitation to contribute to problem definition” (7 May 2017), para 6. 60

Our considerations are consistent with the solutions outlined in Commerce Commission “Related party

transactions – Invitation to contribute to problem definition” (12 April 2017), Table 5.1. 61

As outlined in Chapter 2. 62

Further detail of how we have considered the auditor is provided later in this chapter.

41

4.5.4 whether the new valuation methodology would be able to stay current in

order to account for new developments in the sectors over future

regulatory periods (eg, for the effects of emerging technologies).

In assessing the appropriateness of our new valuation methodology, we have also 4.6

considered submissions on the draft decision paper. We have responded to these

submissions in the relevant sections below.

This chapter should be read in conjunction with the de minimis threshold for 4.7

disclosure requirements in paragraphs 5.6 to 5.13. If regulated suppliers meet a de

minimis threshold, they will have reduced disclosure requirements (including

removing the requirement to commission an independent report outlined in this

chapter).63

Details of our changes and our supporting reasoning

A principles-based approach to valuation and the general valuation rule

Consistent with the draft decision, we have adopted a principles-based valuation 4.8

approach. That is, an amended regime with a general valuation rule which

corresponds more closely to the policy intent. This replaces the list of options

provided in the original prescriptive valuation approach.64

The general valuation rule for related party transactions is that the cost of an asset 4.9

or the value of a good or service acquired from a related party, or the price

received from the sale or supply of an asset or good or service to a related party,

must be set for the purposes of the IMs and ID on the basis that:65

4.9.1 each related party transaction for an acquisition from a related party must

be given a value at not greater than if that transaction had the terms of an

arm’s-length transaction;

4.9.2 each related party transaction for a sale or supply to a related party must

be given a value at not less than if that transaction had the terms of an

arm’s-length transaction; and

63 This threshold is intended to reduce unnecessary compliance costs by making disclosures proportional to

the size and percentage of related party transactions. 64

As a consequence of removing the options for capex, for CPP proposals we no longer require a director

certification by the regulated supplier that it is reasonably satisfied that asset values are consistent with

values determined in accordance with the capex option chosen. 65

Table 4.1 provides reference to the general valuation rule in the IMs and ID determinations.

42

4.9.3 an objective and independent measure must be used in determining the

terms of an arm’s-length transaction.

This general valuation rule aligns directly with the terminology used in the related 4.10

party policy intent, to address the problem that the original related party provisions

were not well aligned with the policy intent. This rule is applied consistently as the

valuation methodology in the IMs (related party capex transactions) and ID (related

party opex and revenue transactions).66

Regulated suppliers will need to disclose a methodology that looks to the 4.11

competitive testing of markets and be seen to apply that methodology in practice.

Auditors of ID disclosures will be required to report against these requirements. 4.12

We consider the principles-based approach: 4.13

4.13.1 ensures that the policy intent and Part 4 purpose are being met;

4.13.2 corrects the issue of the misalignment of the methodology in the IMs and

ID in the original regime, by having an identical valuation methodology

across both determinations for each sector;

4.13.3 has a higher likelihood of covering all of the services likely to be provided

by related parties and better anticipates emerging technology

developments, enabling us to be both service and technology agnostic in

drafting the new determination wording;67

4.13.4 removes determination drafting complexities in the original regime; and

4.13.5 addresses the objective of greater transparency to ensure that related

party transactions are based on arm’s-length terms, and will more easily

enable us to assess any future potential consumer harm.

66 This attempts to address submission comments received on the problem definition paper that the related

party rules in the original IMs and ID were not well aligned. 67

Suppliers of regulated services have varying portfolios offering a range of services and with the

advancement of emerging technologies in both the electricity and gas sectors, our amendments aim to

remain applicable to a range of services and future sector developments.

43

Submissions on our draft decision were supportive of the move to a principles-4.14

based approach. For example, PwC representing a number of EDBs submitted:68

The EDBs which support this submission welcome the Commission’s decision to

introduce a principles based approach to related party transactions, supported and

underpinned by written guidance and the incorporation by reference of accounting

and auditing standards.

Our valuation methodology

Table 4.1 outlines our principles-based valuation methodology, how this is applied 4.15in the IM and ID determinations, and where it is further discussed in this paper.

68 PwC “Submission to the Commerce Commission on Input methodologies review: draft decision on related

party transactions” (27 September 2017), para 5.

44

Table 4.1 Summary of our principles-based valuation methodology and associated assurance features

Consideration Outline Determinations Reasons paper

General valuation rule

(IMs)

The general valuation rule for related party transactions is that the cost of a commissioned asset,

or a component of a commissioned asset, acquired in a related party transaction, must be set on

the basis that:

(a) the cost of a commissioned asset or a component of a commissioned asset acquired in

the related party transaction must be given a value not greater than if that transaction

had the terms of an arm’s-length transaction; and

(b) an objective and independent measure must be used in determining the terms of an

arm’s-length transaction for the purpose of paragraph (a).

IMs Paragraphs 4.8–4.13.

General valuation rule

(ID)

The general valuation rule for related party transactions is that the value of a good or service

acquired in a related party transaction, or the amount received for the sale or supply of assets or

goods or services in a related party transaction, must be set on the basis that:

(a) the value of a good or service acquired in the related party transaction must be given a

value not greater than if that transaction had the terms of an arm’s-length transaction;

(b) the value of an asset or good or service sold or supplied in the related party transaction

must be given a value not less than if that transaction had the terms of an arm’s-length

transaction; and

(c) an objective and independent measure must be used in determining the terms of an

arm’s-length transaction for the purpose of paragraph (a).

ID Paragraphs 4.8–4.13.

45


Value limitation (IMs) The rules incorporate a value limitation:

Where a commissioned asset or a component of a commissioned asset is acquired in the related

party transaction, the value that qualifies for recognition as the cost of a commissioned asset or

a component of a commissioned asset must not exceed the actual amount charged to the

regulated supplier by the related party

IMs Paragraphs 4.20–4.27.

Value limitation (ID) The rules incorporate a value limitation:

Where a good or service is acquired in the related party transaction, the value of the good or

service must not exceed the actual amount charged to the regulated supplier by the related

party


Consolidation

approach (IMs)

A related party transaction will be treated as if it had the terms of an arm’s-length transaction if

the commissioned asset, or component of the commissioned asset, acquired from a related

party is valued at the cost incurred by the related party, provided that this is -

(a) fair and reasonable to the regulated supplier; and

(b) substantially the same as the cost that has been incurred or would be incurred by the

related party in providing the same type of asset to third parties.

IM Paragraphs 4.28–4.30

Consolidation

approach (ID)

A related party transaction will be treated as if it had the terms of an arm’s-length transaction if

the good or service acquired from a related party is valued at the cost incurred by the related

party, provided that this is-

(a) fair and reasonable to the regulated supplier; and

(b) substantially the same as the cost that has been incurred or would be incurred by the

related party in providing the same type of good or service to third parties.

ID Paragraphs 4.28–4.30

46


Independent audit

assurance

requirements (ID)

In satisfying the valuation methodology, the audit assurance opinion states whether the

valuation and disclosure of related party transactions in the disclosure year in all material

respects complies with the general related party transactions valuation rule.

As part of the audit assurance opinion, the auditor must state any ‘key matters’.69


69 We have incorporated these principles from IAS (NZ) 701.

47


Independent report

(ID)

The supplier of the regulated service will be required to seek an independent assurance report if:

(a) the proportion of the regulated supplier’s total opex accounted for by related party

transactions exceeds 65% of the total opex of the regulated supplier in the disclosure

year;70

or

(b) the proportion of the regulated supplier’s total capex accounted for by related party

transactions exceeds 65% of the total capex of the regulated supplier in the disclosure

year; or

(c) the auditor of the ID requirements is unable to conclude that the related party

transactions in the disclosure year in all material respects complies with the general

related party transactions valuation rule; or

(d) the independent auditor issues a modified audit opinion for the disclosure year and time

constraints do not permit the preparation of an independent report for that disclosure

year, in which case the report will need to be provided with the following year’s

disclosures; or

(e) the last prior independent report was not commissioned by the regulated supplier in

respect of one of the immediately prior two disclosure years; and

(f) the total value of related party transactions in opex or capex has increased by 5% or

more between the disclosure year addressed in the prior report.


70 For example, if the related party opex spend was greater than 65% of total opex spend in a disclosure year, then the supplier of the regulated service will be required

to seek an independent report.

48

Expected characteristics of an arm’s-length relationship and transactions

The arm’s-length principle aims to achieve the equivalent of a transaction between 4.16

the supplier of the regulated service and the related party that reflects the

conditions that would have existed if the terms of the transaction had been

governed by market forces between independent parties.

For this purpose we have adopted the wording for ‘arm’s-length transaction’ from 4.17

the definition in auditing standard ISA (NZ) 550:71

Arm’s length transaction means -

A transaction conducted on such terms and conditions as between a willing buyer and

a willing seller who are unrelated and are acting independently of each other and

pursuing their own best interests.

This will ensure that there is a direct linkage between our requirements and the 4.18

work that auditors will carry out to test our requirements under the applicable

auditing standard.

The definition in this case is also consistent with the applicable term used in the 4.19

Electricity Industry Act.72

Value limitations

To ensure that the amended rules do not open the door to adjustments to the 4.20

actual transaction values for regulatory purposes, the rules now incorporate the

following value limitation:

4.20.1 Where an asset or good or service is acquired in the related party

transaction, the value of the asset or good or service must not exceed the

actual amount charged to the regulated supplier by the related party.73

This is intended to set an upper value limit for procured goods, services and assets, 4.21

in order to remove the opportunity for the supplier of the regulated service to add

an additional margin above the actual amount charged when costing it into the

regulated service. Such an additional margin could result in the regulated service

incorporating inefficient costs.

71 External Reporting Board (XRB) “International standard on auditing (New Zealand) 550 – Related Parties

(ISA (NZ) 550).” Compiled November 2016 and incorporating amendments up to and including

October 2016, page 9. 72

Clause 1(2) of Schedule 3 of the Electricity Industry Act 2010. 73

Table 4.1 provides reference to the value limitation in the IMs and ID determinations.

49

Vector submitted that the Commission should reconsider this limit to the general 4.22

valuation test:74

We find it counter-intuitive that suppliers must submit actual costs if their RPT are in

fact below the market. This will ultimately result in such costs being calibrated at the

resetting of a regulatory period (for a price-quality regulated business) at below the

market rate. The consequence of such an outcome is that it will ultimately “lock out”

the market.

However, we disagree that it is counter-intuitive to require regulated suppliers to 4.23

disclose the actual amount charged if this is less than an arm’s-length value

demonstrated based on an objective and independent measure.

We consider that if a regulated supplier is able to procure assets, goods or services 4.24

at below an arm’s-length value, this would ultimately promote the long-term

benefit of consumers. This is because the lower price would result in a lower input

cost for the regulated service.

It is correct that for a price-quality regulated supplier, disclosure of such a lower 4.25

input cost would most likely result in such cost being calibrated at each reset of the

price-quality path, especially if there is a trend to transact at such lower values over

a number of years. However, we do not consider this is a sufficient argument for

restating these actual transaction values up to arm’s-length values for disclosure

purposes.

In our view, any exclusion of competitors (ie, “lock out” of the market) due to 4.26

predatory pricing occurs as a result of the prices actually charged, not as a result of

the values disclosed under ID. We therefore do not consider this exclusion issue

would be appropriately resolved if actual transaction values were required to be

restated for ID purposes, because it could result in the additional recovery of

revenues by the regulated supplier and additional cost to consumers if those

disclosed restated values were then also adopted in setting the price-quality path.

74 Vector “Vector submission on the Review Related Party Transactions Review Draft Decision”

(27 September 2017), paras 14–15.

50

As previously stated in our problem definition paper,75 we have also considered a 4.27

value limitation for sales from a regulated supplier to a related party as part of this

review. Our final decision is that these sales should be disclosed at no less than the

actual amount received from the related party.76

Consolidation approach

In response to submissions,77 our final decision is to retain the consolidation (or 4.28

cost-based) approach as a ‘safe-harbour’ for demonstrating compliance with the

general valuation principle under the IMs and ID determination. Consolidation

combines the accounting figures of the regulated supplier and related parties, and

eliminates inter-company margins.

If the consolidation approach is applied, there is no ability to place margins on 4.29

internal costs. This reduces one potentially significant source of inefficiency in the

price that consumers pay for the regulated service.

We consider that this method for meeting the IM and ID general valuation rule 4.30

meets the policy intent and should be retained as a method of demonstrating

compliance with the IM and ID general valuation rule. This is supported by the ENA,

which suggested that the Commission should continue to permit EDBs to recognise

services using cost-based methods (including the consolidation approach).78

The role of auditors and alignment with related party auditing standard

The auditors completing assurance engagements on suppliers’ annual disclosures 4.31

will be required to provide an assurance report as to whether, in the independent

auditor’s opinion, the supplier of the regulated service has complied in all material

respects with the requirements of the relevant ID determination.79 If the supplier of

the regulated service has not complied with the requirements, the assurance report

must state the requirements not met.

75 Commerce Commission “Related party transactions – Invitation to contribute to problem definition”

(12 April 2017), para 2.8. 76

Although, these transactions are not a focus of our review and are much less common than related parties

supplying the regulated supplier. 77

For example, Unison “Valuation of Related Party Transactions” (27 September 2017), page 2. 78

ENA “Input methodologies Review Draft decision on related party transactions: Submission to the

Commerce Commission” (27 September 2017), para 12. 79

The ID determinations include: Electricity Distribution Information Disclosure Amendments Determination

2017 [2017] NZCC 33, clause 2.8.1(1)(c); Gas Distribution Information Disclosure Amendments

Determination (No.2) 2017 [2017] NZCC 34, clause 2.8.1(1)(c); and Gas Transmission Information

Disclosure Amendments Determination (No.2) 2017 [2017] NZCC 35, clause 2.8.1(1)(c).

51

Our amendments aim for greater alignment with auditing standards terminology to 4.32

reduce interpretation issues. By aligning our determinations with auditing

standards, we intend to also provide interested persons with increased certainty as

to the level of testing required by the auditor in order to provide assurance that the

related party transactions meet the arm’s-length principle.

Following submissions on our draft decision, our final decision incorporates key 4.33

principles from the standards in the ID determinations rather than the standards

themselves.80

Further detail of how we have incorporated the relevant auditing and accounting 4.34

standards by reference in accordance with the Act is provided in Attachment D of

this paper.

Updated auditor requirements

In order not to overcomplicate or cause interpretation issues for the users of these 4.35

rules, we have aligned the ID independent assurance requirement with the related

party transaction auditing standard and the principles in the applicable accounting

standard.

These standards now provide the related party transaction terms included in our 4.36

general rule, eg, the arm’s-length principle. We are not attempting to re-interpret

such terms.

Without limiting the nature and purpose of the audit assurance report generally, 4.37

we have outlined the updated auditor requirements for related party transactions

as part of the ID external assurance report requirements.

Auditors will be expected to complete a review of the disclosure requirements for 4.38

related party transactions in accordance with the International Standard on

Assurance Engagements (New Zealand) 3000, Assurance Engagements Other than

Audits or Reviews of Historical Financial Information and Standard on Assurance

Engagements 3100 – Compliance Engagements.81

80 PwC in capacity as auditors “Submission to the Commerce Commission on Input methodologies review:

draft decision on related party transactions” (27 September 2017), paras 24–30. We also obtained

feedback from the OAG about drafting of the determination, as it is the appointer of a number of auditors

in the EDB sector where these rules would be applied. 81

International Standard on Assurance Engagements (New Zealand) 3000, Assurance Engagements Other

than Audits or Reviews of Historical Financial Information, issued by the New Zealand Auditing and

Assurance Standards Board of the External Reporting Board in July 2014, under s 12(b) of the Financial

52

In order to test compliance with the valuation methodology, the updated assurance 4.39

opinion will need to state whether the valuation and disclosure of related party

transactions in the disclosure year, in all material respects, demonstrates

compliance with the general related party transactions valuation rule.

Our amendments to the valuation methodology may lead to future qualified audit 4.40

opinions in relation to related party transactions. In situations where a qualified

audit opinion is provided, auditors may be guided by international standards.82

Although our final decision is to not incorporate some of these standards by

reference into the ID determinations, as proposed in our draft decision,83 we will

instead require the assurance report to state any ‘key audit matters’. These ‘key

audit matters’ directly incorporate the relevant principles from International

Standard on Auditing (New Zealand) 701 (ISA (NZ) 701).84

We identified that auditors may face difficulties in assessing arm’s-length terms 4.41

where there are imperfect local markets, ie, where the related party is the only

provider of a service in a region. In those cases, we would expect that regulated

suppliers in these types of markets and their auditors might consider costs of

similar services provided around New Zealand in benchmarking costs and possibly

seek expert external advice to complete benchmarking.

If the auditor is unable to conclude that the related party transactions are on terms 4.42

equivalent to arm’s-length, we expect the regulated supplier would receive a

modified assurance opinion. Under the auditing standards, a ‘modified’ assurance

opinion could be a disclaimer of opinion, a qualified opinion or an adverse opinion,

which will depend on the reasons for the auditor being unable to conclude on an

unqualified assurance opinion.

Reporting Act 2013; Standard on Assurance Engagements 3100 – Compliance Engagements issued by the

External Reporting Board, under s 24(1)(b) of the Financial Reporting Act 1993. 82

Such comments could be provided in ‘emphasis of matter’ or ‘other matter’ paragraphs. This is consistent

with the New Zealand equivalents to the International Standards on Auditing in respect of financial

statements: No. 700: Forming an Opinion and Reporting on Financial Statements; No 705: Modifications to

the Opinion in the Independent Auditor’s Report; and No. 706: Emphasis of Matter Paragraphs and Other

Matter Paragraphs in the Independent Auditor’s Report. 83

See PwC in capacity as auditors “Submission to the Commerce Commission on Input methodologies

review: draft decision on related party transactions” (27 September 2017), paras 24–30. 84

International Standard on Auditing (New Zealand) 701, Communicating Key Audit Matters in the

Independent Auditor’s Report, issued by the New Zealand Auditing and Assurance Standards Board of the

External Reporting Board in October 2015, under s 12(b) of the Financial Reporting Act 2013.

53

If the related party transacts with third parties as well as the regulated supplier, 4.43

reference to the related party’s pricing of equivalent transactions with those third

parties, if available, may support the auditor’s conclusion on the arm’s-length

principle.

It will be up to the auditor’s professional judgement as to whether it can gain 4.44

sufficient evidence to conclude on whether the transaction terms are consistent

with the arm’s-length principle. Being able to do this will depend on whether the

auditor can obtain sufficient information to show that the transaction terms

between the related party and the third parties are largely consistent with those

between the related party and the regulated supplier.

In our audit rules, we have included a threshold to allow auditors and independent 4.45

appraisers to assess the compliance of the supplier of the regulated service above a

level of materiality as determined by the auditor’s judgement.85

The form of assurance report

The ID determination sets out the form of the assurance report, which is based on 4.46

the auditing standards for forming an opinion on financial statements. Those

auditing standards were recently updated and they provide more detailed guidance

than the assurance standards on which the independent report is based.86

Independent report to provide additional assurance

In circumstances where the related party transactions are a material proportion of 4.47

the disclosure year’s total opex or capex spend, or the auditor is not able to come

to an unqualified opinion in its assurance report on related party transactions, the

supplier of the regulated service will be required to seek a further report from an

independent expert. This report must be disclosed publicly by the regulated

supplier.

85 This was also suggested by PwC: PwC in capacity as auditors “Submission to the Commerce Commission on

Input methodologies review: draft decision on related party transactions” (27 September), para 21. 86

For further explanation, the Office of the Controller and Auditor-General provides summarised guidance

on types of audit reports on its web site at http://www.oag.govt.nz/2014/central-

government/appendix1.htm.

http://www.oag.govt.nz/2014/central-government/appendix1.htm

http://www.oag.govt.nz/2014/central-government/appendix1.htm

54

The supplier of regulated services would be required to obtain and disclose an 4.48

independent report if:

4.48.1 the proportion of the regulated supplier’s total opex accounted for by

related party transactions exceeds 65% of the total opex of the regulated

supplier in the disclosure year; or

4.48.2 the proportion of the regulated supplier’s total capex accounted for by

related party transactions exceeds 65% of the total capex of the regulated

supplier in the disclosure year; or

4.48.3 the independent auditor of the ID requirements is unable to conclude that

the related party transactions in the disclosure year (or the prior disclosure

year if the auditor provides a qualified opinion and the independent report

us unable to be commissioned in time), in all material respects, meet the

general valuation rule; or

4.48.4 the independent auditor has issued a modified assurance opinion for the

valuation and disclosures of related party transactions for the preceding

year and time constraints have prevented the preparation of an

independent report for that disclosure year. In this instance, we require

the regulated supplier to publicly disclose a statement indicating that they

will publicly disclose an independent report for the preceding disclosure

year.

The supplier of regulated services will not be required to obtain and disclose this 4.49

independent report if:

4.49.1 the last prior report was commissioned by the supplier in respect of one of

the immediately prior two disclosure years; and

4.49.2 the total value of related party transactions of the supplier in each of opex

or capex (as applicable) has not increased by more than 5% for any

disclosure year since the disclosure year addressed in the last prior report.

The supplier of regulated services will also not be required to obtain and disclose 4.50

this independent report if the regulated supplier meets a de minimis threshold, as

outlined in Chapter 5.

55

In its audit submission, PwC questioned whether the 5% increase trigger is the most 4.51

appropriate threshold to use:87

The auditors’ opinion on the disclosure of consistently applied policies should provide

comfort that the policies and information disclosed previously remains appropriate.

This was reiterated by other submissions that suggested that the requirement for 4.52

an independent report should only be triggered in instances where the auditor

cannot form an opinion.88

We consider that even if the auditor is able to form an opinion, it is still appropriate 4.53

and consistent with the purpose of information disclosure regulation in section 53A

of the Act to require an independent report. For suppliers of the regulated service

that have a high proportion and value of related party transactions, requiring an

independent report to be obtained and disclosed should provide additional

transparency and tell the story behind the transactions (even if the auditor is able

to form an opinion on the appropriateness of values).

This independent report will tell the story behind the related party transactions 4.54

where one of the requirements in paragraph 4.48 applies. This will provide

interested persons with sufficient information to understand the extent to which

the policy intent, and the purpose of Part 4 of the Act are or are not being met (and

why) in situations where there is increased potential for consumer harm.

We note that the auditor undertaking the assurance engagement may be engaged 4.55

to complete this report, but the supplier of the regulated service may also choose a

different independent expert to provide this report (we refer to the author of the

independent report as the ‘independent appraiser’). We consider that an

independent report on valuation by a non-audit expert might be adopted by the

auditor under the auditing standards in forming an overall audit opinion on the ID

disclosures in the following (or current) disclosure year.


draft decision on related party transactions” (27 September 2017), para 44. 88 For example, Powerco “RE: Input methodologies review draft decision - related party transactions”

(27 September 2017), page 3.

56

The independent report will: 4.56

4.56.1 be addressed to the directors of the regulated supplier and to the

Commission as the intended users of the report;

4.56.2 be independent of the independent auditor’s assurance report;

4.56.3 be based on the information obtained, sampling of related party

transactions and analysis undertaken, and state whether or not in the

opinion of the independent appraiser, the regulated supplier’s related

party transactions would comply, in all material respects, with the related

party provisions, and set out the grounds for that opinion;

4.56.4 where the independent appraiser provides an opinion in the report that

the related party transactions would not comply with our related party

provisions, state the appraiser’s opinion on the alternative transaction

terms that could enable compliance with the arm’s-length requirements;

4.56.5 set out the qualifications of the independent appraiser to provide the

opinion in the report;

4.56.6 set out the scope and any limitations of the engagement of the

independent appraiser by the regulated supplier;

4.56.7 state all key assumptions made by the independent appraiser on which the

analysis in the report relies;

4.56.8 describe the basis used by the independent appraiser for sampling of

related party transactions to inform the opinion in the report;

4.56.9 describe the steps and analysis undertaken;

4.56.10 summarise the steps the regulated supplier has taken to test whether

related party transactions comply with the related party provisions;

4.56.11 state whether or not, in the opinion of the independent appraiser, the

steps taken by the regulated supplier are, considered to be, in all material

respects, reasonable in the circumstances; and

4.56.12 state whether the independent appraiser has obtained recorded

information and explanations that they required and, if not, the

information and explanations not able to be obtained.

57

We have reduced the level of prescriptiveness for the independent report from 4.57

that which was set out in the draft ID determination, and have removed the

requirement to disclose the steps taken by directors and management to test

whether the related party transactions comply with the general valuation rule.89

We are not prescribing the analysis required for the independent report, as this will 4.58

vary based on the circumstances of the regulated supplier. However, we expect

such analysis may include the review of financial records, business transactions,

accounting practice and internal controls in respect of disclosed related party

transactions of the regulated supplier.

In its audit submission, PwC queried how the opinion required from the 4.59

independent report would differ from the auditors’ report when setting out

whether the ID and IM determination had been complied with.90

The independent report is designed to be a more thorough investigation into the 4.60

related party transactions and will explain the circumstances and background of the

related party transactions. This is intended to provide information to interested

persons about the related party transactions.

Regulated suppliers that are likely to provide an independent report initially

Based on the 2016 ID data, we consider the following suppliers could be required to 4.61

provide an independent report:91

4.61.1 Alpine Energy;

4.61.2 Aurora Energy;

4.61.3 OtagoNet;

4.61.4 The Lines Company;

4.61.5 Electra;

4.61.6 Northpower; and

89 Submissions on our draft decision suggested reducing the prescriptiveness of the independent report, for

example: PwC “Submission to the Commerce Commission on Input methodologies review: draft decision

on related party transactions” (27 September 2017), para 40. 90 PwC in capacity as auditors “Submission to the Commerce Commission on Input methodologies review:

draft decision on related party transactions” (27 September 2017), para 39. 91

These suppliers had at least 65% related party expenditure for opex and/or capex, and would not have

met the de minimis thresholds if those thresholds had applied in that disclosure year.

58

4.61.7 The Power Company Limited.

Linking our amended valuation methodology with the IM and ID determinations

Our valuation options for related party transactions are split across two 4.62

determinations with the ID determinations covering related party opex and

revenue transactions and the IMs covering related party capex.92

Table 4.2 links the elements from our principles-based valuation methodology with 4.63

the provisions in the amendments determinations.

92 Further detail of this split is provided in paras 2.12 to 2.19 of this paper.

59

Table 4.2 Cross-reference of our principles-based methodology

Elements of the

valuation methodology

IM ID Reference

General valuation rule Provided in the IMs for related

party capex valuations.

Provided in ID for related party opex and revenue

valuations.

IM clauses 2.2.11(1) and 2.2.11(5)

ID clauses 2.3.6(1)-(3)

Value limitation Provided in the IMs for related

party capex valuations.

Provided in ID for related party opex valuations. IM clauses 2.2.11(1) and 2.2.11(5)

ID clause 2.3.6(4)

Indicative examples of

arm's-length

transactions

Not included in the determinations. A guidance note is provided in the ID determinations

to guide interested persons from the determinations to the relevant part of this paper.

Attachment B provides worked examples of transactions on arm’s-length and non-arm’s-

length terms to provide greater clarity for those applying the valuation methodology.

Attachment B of this paper.

Independent audit

requirement

Not included in the IMs. Provided in ID. ID clauses 2.8.1(1)-(2)

Independent report Not included in the IMs. Provided in ID. ID clauses 2.8.2-2.8.5

Relationship between

cost allocation and

related party

transactions

Not provided for in the determinations. Attachment A outlines how paragraphs (a) and

(b) of the related party definition are expected to apply with the cost allocation rules.

Attachment C sets out the relationship between the cost allocation and related party

provisions to provide greater clarity to those applying the rules. A guidance note is

provided in the ID determinations to guide interested persons from the determinations

to the relevant part of this paper.

Attachment A and Attachment C

of this paper.

60

Our amendments to key definitions

We have amended key definitions to provide for greater clarity. We note 4.64

submissions received on the complexity of the original terminology. For example,

as a result of the move to the principles-based approach, there is no longer the

term ‘directly attributable costs’ in our determinations.93

An outline of our key definitions is provided in Table 4.3. 4.65

93 In response to PwC “Input methodologies review: Related party transactions – invitation to contribute to

problem definition” (17 May 2017), Appendix A.

61

Table 4.3 Our amendments to key definitions

Term Outline94

Status Determination

reference

Arm’s-length

transaction

Arm’s-length transaction means-

A transaction conducted on such terms and conditions as between a willing buyer and a

willing seller who are unrelated and are acting independently of each other and

pursuing their own best interests.95

Update IM clause 1.1.4(2)

ISA (NZ) 550 ISA (NZ) 550 means-

International Standard on Auditing (New Zealand) 550, Related Parties, issued by the

New Zealand Auditing and Assurance Standards Board of the External Reporting Board

in July 2011 and amended effective 15 December 2016, under s 24(1)(b) of the Financial

Reporting Act 1993.

New ID clause 1.4.3

Related party Related party means-

(a) a person that is related to the regulated supplier, where the regulated supplier

would be considered as the ‘reporting entity’, as specified in the definition of

‘related party’ in NZ IAS 24; or

(b) any part of the regulated supplier that does not supply regulated services.


94 When referring to the regulated supplier we mean the EDB, GDB or GTB as applicable in the appropriate determinations. When referring to regulated service that is,

the electricity distribution services or gas pipelines services as applicable in the appropriate determination. 95

Definition taken directly from ISA (NZ) 550.

62

Term Outline94

Status Determination

reference

Related party

transaction

Related party transaction means -

(a) the procurement of an asset or good or service from a related party by the part

of the regulated supplier that supplies the regulated service; or

(b) the sale or supply of an asset or good or service to a related party by the part

of the regulated supplier that supplies the regulated service.


63

Interpreting the definition of ‘related party’ and applying it in combination with cost

allocation

We have amended the definition of ‘related party’ in the IMs to: 4.66

Related party means-

(a) a person that is related to the [EDB/GDB/GTB], where the [EDB/GDB/GTB] would be

considered as the ‘reporting entity’, as specified in the definition of ‘related party’ in

NZ IAS 24;96

or

(b) any part of the [EDB/GDB/GTB] that does not supply [electricity distribution

services/gas distribution services/gas transmission services].

Submissions on our draft decision paper sought the removal of paragraph (b) of the 4.67

definition of ‘related party’. For example, Marlborough Lines Limited stated in its

submission:97

We submit that part (b) of the Related Party definition be removed and the

Commission revert to a definition that would line up with the accounting standards

definition of a Related Party, which requires a separate legal entity.

Paragraph (b) of the definition is included because the Commission regulates 4.68

services and does not regulate the legal entity that supplies those services. From a

policy intent point of view we consider that our related party transactions rules

should address the various ways in which costs are charged to the regulated

service, including charges made to the regulated service from an unregulated part

of the entity.98

We do not agree with arguments that removal of paragraph (b) from the definition 4.69

of ‘related party’ would not compromise the policy intent. We consider that

removing paragraph (b) could create a risk that internal transactions between the

part of the entity that supplies the regulated service, and the part of the same

entity that does not supply the regulated service, may not be disclosed on terms

equivalent to arm’s-length.

This is critical to consumers, because some of the costs of those transactions may 4.70

also be inputs into the regulated service.

96 A ‘reporting entity’ is defined in NZ IAS 24 as the entity that is preparing its financial statements. In this

case, the entity is the regulated supplier. 97

Marlborough Lines Limited “Submission to the Commerce Commission on related party transactions Draft

decision and determinations guidance” (27 September 2017), para 24. See also, for example, Unison

“Valuation of Related Party Transactions” (27 September 2017), pages 6–7. 98

For example, section 54E of the Act states that the electricity lines service is regulated. Section 54C of the

Act outlines the meaning of electricity lines services.

64

Accordingly, we consider that removing paragraph (b) and aligning the definition 4.71

strictly to the definition of a related party under the accounting standards could

materially weaken the achievement of the policy intent of the related party regime.

We have therefore decided to retain paragraph (b) of the ‘related party’ definition.

Treating a ‘part’ of the regulated supplier as the business equivalent of a separate 4.72

legal subsidiary or other related company of the regulated supplier could allow that

internal part to charge for services on arm’s-length terms and derive unregulated

arm’s-length margins as if it was a subsidiary.

We consider that removing paragraph (b) would change the neutrality of treatment 4.73

between internal and external business structures for the purposes of these rules

and seems likely to incentivise regulated suppliers to move their unregulated

activities into subsidiary companies. It may also disincentivise regulated suppliers

from business innovation that is ultimately of value to customers of the regulated

service.

We note from submissions on our draft decision paper that submitters were 4.74

unclear what “parts, branches or divisions” of the regulated supplier are that do

not supply the regulated service.99

As Powerco stated in its submission:100 4.75

Our concern relates to the second tier of the definition. It is unclear from the

information provided exactly what ‘parts, branches and divisions’ of a regulated

business would be considered to be a related party, i.e. deemed to not supply

regulated services.

We have therefore reverted in paragraph (b) of the amended definition to the 4.76

simpler “any part” in place of the proposed “parts, branches or divisions” and will

be giving guidance to the regulated sectors on what a ‘part’ means.

To identify a ‘part’ of a regulated supplier first requires the definition of the 4.77

regulated service and then the identification of activities and costs that are

fundamental to providing that regulated service. Conversely it requires the

identification of activities and costs that would allow the ‘part’ to operate as a

separate business unit of the regulated supplier.

99 Commerce Commission “Input methodologies review draft decision – Related party transactions – Draft

decision and determinations guidance” (30 August 2017). 100

Powerco "RE: Input methodologies review draft decision - related party transactions" (27 September

2017), page 2. See also, for example, Marlborough Lines Limited "Submission to the Commerce

Commission on related party transactions Draft decision and determinations guidance" (27 September

2017), pages 2-4.

65

We looked at whether there are quantifiable dimensions that could be used to 4.78

identify a ‘part’ so it would be clearer when the related party rules apply to internal

business activities. In doing so, we considered whether to set brightline criteria in

order for an unregulated business activity of a regulated supplier to be considered

as a related party for the purposes of the related party transactions rules, but have

concluded in line with our principles-based approach that this would be counter to

our conclusions on updating the valuation rules.

We concluded based on our discussions with sector participants over the course of 4.79

examining the related party transaction issues that business models are variable

across both sectors and that it would not be practical to set criteria for when those

business activities become a ‘part’.

This does theoretically leave open a risk that regulated suppliers could seek to 4.80

convert elements of their regulated services into separate business units to allow a

higher rate of return through pricing those cost elements up to an arm’s-length

equivalent value.

However, for guidance to regulated suppliers we note that when we ultimately 4.81

evaluate the information disclosures made in response to the related party

transactions requirements set out in Chapter 5, we will be thinking about whether

any internal related party for which disclosures are made would be capable of

being considered a severable business from the regulated service, essentially

considering what, if anything, distinguishes:

4.81.1 a ‘part’ of the regulated supplier that sells to the regulated service and to

other external customers; and

4.81.2 a regulated service that derives some revenues selling unregulated

services to external customers.

Indicative factors we could consider might include whether the business has the 4.82

management and operating structure we would expect of a standalone business,

and whether it already has the scale of third party sales and a clear focus on

growing external sales and reducing reliance on internal sales that would be

expected of such a business.

For example, where an internal part of the regulated supplier has been operating 4.83

for some time as an identified business unit, its unregulated supplies to external

customers exceed the unregulated supplies to the regulated service, and the

unregulated service has a management, sales and support structure that seems

theoretically capable of being separated from the regulated supplier, we would be

likely to conclude that this is a ‘part’ of the regulated supplier for the purposes of

paragraph (b).

66

Conversely, we would not expect a regulated supplier with a mere de minimis level 4.84

of sales to third parties (for example, in an initial growth phase of the unregulated

business unit), or with no established and tangible business structure, to be treated

as a ‘part’ of the regulated supplier for the purposes of the related party

transactions rules. In those instances we would instead expect to see a cost-based

approach disclosed.

In the event that we see future sector business structuring that we consider 4.85

undermines the related party transactions policy intent, our response could be a

move back toward a more prescriptive and less flexible cost-based approach.

Paragraphs (a) and (b) of the related party definition can apply in different 4.86

combinations depending on how a regulated supplier is structured from an

ownership and operational point of view, and how it transacts with other

companies. For example, in a case where a regulated supplier provides both

regulated services and unregulated services:

4.86.1 If the regulated supplier does not have a separate business unit that

charges costs to the regulated service, and input costs are charged to the

regulated supplier by an unrelated third party, the cost allocation rules

deal with how the transaction values of those input costs are to be

allocated between the services;

4.86.2 If external input costs are charged to the regulated service through a

separate business unit of the regulated supplier (ie, a ‘part’) at the

transaction cost charged by the unrelated third party, and they include no

additional margin for the ‘part’ on top of that transaction cost, the cost

allocation rules apply; and

4.86.3 If the amount charged to the regulated service by the internal ‘part’

includes a further margin and is therefore more than just a pass-through of

third party charges to the regulated service, the related party transactions

rule applies in combination with the cost allocation rules.101

101 Although we can see the potential for “double dipping” of shared costs in the paragraph (b) ‘part’ of the

regulated supplier through the cost structure of the ‘part’ and through the cost allocation rules in the

regulated service, this is something that we expect will be disclosed through the information disclosures in

Chapter 5.

67

A logical way to apply the related party rule, if applicable, and the cost allocation 4.87

rules is to first value the transactions at an arm’s-length value under the related

party valuation rule and then to make any necessary allocation of the resulting

arm’s-length value using the cost allocation rules.

To help interested parties understand the rules, we provide guidance in 4.88

Attachment A on how the related party transaction rules and cost allocation rules

would work in combination under a series of scenarios.

We provide a diagram in Attachment C that shows how and when to value a 4.89

transaction with a related party that has a cost allocation requirement.

To give regulated suppliers a further opportunity to ask questions about the 4.90

practical application of these rules to their circumstances, we also intend to include

this topic as part of our education sessions in 2018.

We note that in our draft decision, we proposed providing a guidance note in the 4.91

IM determinations on the interpretation of paragraph (b) of the ‘related party’

definition, as well as on other areas of the IM determinations. Some submissions

considered that guidance notes should not be included in the IMs and ID

determinations.102

We agree and have therefore removed the guidance notes from the IM 4.92

determinations. However, we still think it is appropriate to retain guidance notes in

the ID determinations in the interests of guiding regulated suppliers and interested

persons through the disclosure requirements.

102 For example, see PwC “Submission to the Commerce Commission on Input methodologies review: draft

decision on related party transactions” (27 September 2017), para 42.

68

Chapter 5 Our amended related party disclosure

requirements



5.1.1 an outline of our amended related party disclosure requirements;

5.1.2 our reasons for the amendments; and

5.1.3 comments on our consideration of relevant submissions we have received

on the draft amended disclosure requirements.

Our related party disclosure requirements

As outlined in our problem definition paper, we consider that the original related 5.2

party transactions provisions provided limited transparency to enable stakeholders

to assess whether:

5.2.1 the cost of a good or service acquired from a related party, is set on the

basis that each related party transaction is valued at not greater than if it

had the terms of an arm’s-length transaction;

5.2.2 the price received from the sale or supply of an asset or good or service to

a related party, is set on the basis that each related party transaction is

valued at not less than if it had the terms of an arm’s-length transaction;

5.2.3 the value of a related party transaction is based on an objective and

independent measure; and

5.2.4 cost efficiencies are being shared with consumers of the regulated service.

Our original ID requirements for related party transactions were focussed on 5.3

quantitative data collection and may not have provided sufficient qualitative

information that is readily available to interested persons to assess whether the

Part 4 purpose is being met as set out in s 53A.

We have amended our rules to promote greater transparency of related party 5.4

transactions to ensure that these transactions comply with the policy intent and to

ensure that the s 53A ID purpose is being met. We have made some amendments

to the disclosure requirements in response to submissions on our draft decision. In

particular, we removed some of the disclosure requirements proposed in our draft

decision to reduce compliance costs on suppliers.

69

The ID amendments we have made are set out under the relevant headings below. 5.5

Limited disclosure requirements in some cases

In situations where a regulated supplier has minimal related party transactions or 5.6

otherwise has lower levels of total expenditure, we are less concerned that our

policy intent would not be met. Therefore, requiring compliance with the full

related party rules may not be a proportionate response.

We agreed with submissions on our draft decision that requiring all suppliers to 5.7

comply with the full disclosure requirements may impose disproportionate

compliance costs on some suppliers.103

Submissions on our draft decision proposed introducing a de minimis threshold for 5.8

application of the related party rules and disclosure requirements.104 As Vector

stated in its submission:105

The cost of having low value transactions subject to the disclosure requirements and

the general valuation rule will increase the administrative burden and costs for

compliance and outweigh any benefit to be gained. A de-minimis threshold also

provides a clear protection for the customer from having inflated costs included in the

regulated service price.

We consider that a de minimis threshold will ensure that compliance costs are 5.9

proportionate to the size of the supplier and its level of related party transactions.

Our decision is that the de minimis thresholds, below which only limited disclosure 5.10

is required, will be where a supplier has:106

5.10.1 total annual expenditure of $20 million or less; or

5.10.2 under 10% of total annual expenditure made up of related party

transactions.


draft decision on related party transactions” (27 September 2017), para 11. 104

For example, Powerco “RE: Input methodologies review draft decision – related party transactions”

(27 September 2017), page 3. 105

Vector “Vector submission on the Review Related Party Transactions Review Draft Decision”

(27 September 2017), para 8. 106




NZCC 34, clause 2.3.9.

70

We consider that the de minimis threshold requirements strike a reasonable 5.11

balance between cost on suppliers and effectiveness of the regime. We used our

judgement to set the annual expenditure de minimis threshold and the percentage

of related party transactions de minimis threshold at values that we consider will

ensure that sufficient information is provided for interested persons to be able to

evaluate whether the purpose of Part 4 is being met, but would also exclude any

requirement for full disclosures by regulated suppliers where the resulting

compliance cost is likely to be disproportionate to the value to interested persons

of such disclosures.

Regulated suppliers that do not meet a de minimis threshold for a given disclosure 5.12

year will be required to comply with the disclosure requirements set out in the

following sections. The full disclosure requirements are summarised in Table 5.1.

Table 5.2 then compares the disclosure requirements for full disclosure with the

more limited level of disclosures when a regulated supplier meets a de minimis

threshold.

We reviewed the potential application of the de minimis thresholds to EDBs, being 5.13

the larger group of regulated suppliers for which related party information is

available. Based on the 2016 ID data for EDBs, we estimate that in the first

disclosure year:

5.13.1 ten regulated suppliers will be required to comply with the full disclosure

requirements; and

5.13.2 nineteen regulated suppliers will only be required to comply with limited

disclosure by meeting a de minimis threshold.

71

Table 5.1 Related party disclosure requirements

Area Overview107

Reference

Related party

relationships

A diagram or a description that shows the connection between the regulated supplier and the related

parties with which it has had related party transactions in the disclosure year, including for each of those

related parties -

(a) the relationship between the regulated supplier and the related party

(b) the principal activities of the related party; and

(c) the total annual expenditure incurred by the regulated supplier with the related party.

ID clause 2.3.8

Procurement

policies and

processes

Where the regulated supplier transacts with related parties in the disclosure year, provide a copy of the

current procurement policy or alternate documentation. We note that the regulated supplier will be

required to disclose a summary of the current procurement policy or alternative documentation publicly and

the full version to the Commission.

A description of how the regulated supplier applies its policy for the procurement of assets or goods or

services from a related party in practice.

A description of any policies or procedures that require or have the effect of requiring a consumer to

purchase assets or goods or services from a related party that are related to the supply of the regulated

service.

ID clauses 2.3.10 – 2.3.11,

2.3.12(1)–(2)

107 When referring to the regulated supplier we mean the EDB, GDB or GTB, as applicable, in the appropriate determinations. When referring to regulated services we

mean the electricity distribution services or gas pipelines services, as applicable, in the appropriate determination. Full drafting detail can be found by following the

references column.

72

Area Overview107

Reference

Practical

application of the

procurement

policies and

processes

Where the regulated supplier transacts with related parties, disclose consistency of the practical application

with the procurement policy through at least one representative example. Where a regulated supplier

applies the current procurement policy differently between expenditure categories, it must provide separate

representative examples that demonstrate the significant differences.

ID clauses 2.3.12(3), (5)

Most recent

examples of

market testing of

transaction terms

Where the regulated supplier transacts with related parties, for at least one representative example, show

how and when the regulated supplier last tested the arm’s-length terms, by reference to market

transactions. If there are significant differences between how the market has been tested for different

expenditure categories, the regulated supplier must provide separate representative examples that

demonstrate the differences.

ID clause 2.3.12(4)

73

Area Overview107

Reference

Map of anticipated

network

expenditure and

network

constraints

Where a regulated supplier has related party transactions during the disclosure year, the regulated supplier

must publicly disclose a map of its regulated service territory, which includes –

(a) A brief explanatory description of the ten largest forecast opex projects in the asset management

plan (AMP) planning period and the likely timing, value and location of the projects;

(b) A brief explanatory description of the ten forecast capex projects in the AMP planning period and

the likely timing, value and location of the projects;

(c) A brief explanatory description of possible future network or equipment constraints and their

location, where the responses to the constraints would involve one of the ten largest future opex

projects in the AMP planning period; and

(d) A brief explanatory description of possible future network or equipment constraints and their

location, where the responses to the constraints would involve one of the ten largest future capex

projects in the AMP planning period.

The map must –

(a) Identify whether the forecast or possible opex or capex is-

a. Already subject to a contract, and, if so, whether that contract is with a related party;

b. Forecast to require the supply of assets or goods or services by a related party; or

c. currently not indicated for supply by a related party; and

(b) Be consistent with the AMP information on –

a. Network or equipment constraints;

b. Projected impact of demand management initiatives (EDBs only);

c. Network development programmes.

ID clauses 2.3.13–2.3.16

74

Table 5.2 Disclosure requirements for regulated suppliers on full and limited disclosure

108 In our final decision, we have amended Schedule 5b of the EDB, GDB and GTB ID determinations. We proposed changes as part of our draft decision and received no

submissions on our proposed changes.

Requirement Full disclosure (do not meet a de

minimis threshold)

Limited disclosure (meet a de minimis

threshold)

Related party relationships

Procurement policies and processes X

Practical application of the procurement policies and processes X

Recent examples of market testing X

Map of anticipated network expenditure and network constraints X

Valuation methodology

Report on Related Party Transactions (Schedule 5b)108

Audit and assurance requirements

Independent report X

75

Reasoning for our disclosure areas

Related party relationship

We have included a requirement to publish a diagram or description that explains 5.14

the relationships between the related party and the supplier of regulated services

to provide the Commission and interested persons with an overview of the

business structure. We consider that such disclosure will provide interested

persons with a high level overview of these regulatory structures.109

The relationships intended to be covered would be ownership, governance and 5.15

senior management between the parties. We consider such disclosure should be

low cost for suppliers of regulated services to provide, as most will already have

this information internally.

In response to concerns around compliance costs on our draft decision, we have 5.16

reduced the specificity of this disclosure area in the ID determination.110 In

particular, we have removed some of the requirements, including the requirement

to disclose:

5.16.1 any common board or senior management;111 and

5.16.2 any common control or influence.

Procurement policies and processes

The disclosure of procurement policies and processes behind the procurement of 5.17

assets and services from the related party helps to provide the required level of

disclosures for interested persons to assess whether the related party transactions

are meeting the related party policy intent and the Part 4 purpose. That is, that

related party transactions do not adversely affect efficiency, profit, price and

quality regulatory objectives.

109 We agree with Pioneer’s comment in its submission on the problem definition paper that if the regulated

EDB selects a related party to be the supplier, and not a third party, the related party provisions must

make the details of a related party transaction transparent. Pioneer Energy “Re: Related party transactions

– invitation to contribute to problem definition” (17 May 2017), page 2. 110




NZCC 35, clause 2.3.8. 111

PwC suggested less prescriptive disclosures focused on the nature and extent of related party

relationships in their submission on our draft decision; PwC in capacity as auditors “Submission to the

Commerce Commission on Input methodologies review: draft decision on related party transactions”

(27 September 2017), para 13.

76

We have included this area of disclosure to ensure greater visibility, transparency 5.18

and verification that regulated suppliers are delivering cost efficient assets and

services.112

We have considered the following point from the Genesis submission on our 5.19

standard track ID amendments process:113

3. Mandate disclosure of procurement processes generally and actual disclosure of

the details of the process where an investment is over a specified threshold

This would increase the ability of interested persons to ascertain whether a robust

procurement process was adhered to, particularly when procuring non-network

solutions. At present, it is difficult to ascertain the extent to which EDBs give proper

consideration to non-network solutions to deal with forecasted constraints and, in

particular, whether EDBs adequately consider the use of customer-sited batteries.

Although the submission has a technology solution angle, we agree with Genesis’ 5.20

general point about the transparency of procurement processes and we have

factored this into our solutions in a technology agnostic way.

We require a summary of the procurement policy information to be disclosed 5.21

publicly with a full version of such documentation to be provided to the

Commission. We consider this approach:

5.21.1 allows interested persons to identify whether a supplier has a

procurement policy or not, and to examine any procurement policy; and

5.21.2 deals with any potential commercial confidentiality issues.

112 The consideration for procurement policies is included in the following submissions on the problem

definition paper: Asplundh “Input methodologies review – related party transactions – Invitation to

contribute to problem definition / initial findings” (17 May 2017), page 1. Genesis Energy “Input

methodologies review – Related party transactions – Invitation to contribute to problem definition”

(17 May 2017), page 2. 113

Submission received from Genesis on “Commerce Commission Proposed amendments to information

disclosure determinations for airport services, electricity distribution services, and gas pipeline services,

Draft companion paper” (30 June 2017). Genesis Energy Limited “Proposed amendments to information

disclosure determinations” (28 July 2017), page 5.

77

Some submissions on our draft decision did not support the publication of a 5.22

summary of procurement policies.114 We consider that both disclosure of

procurement policies and the publication of the summary of procurement policies

better enables interested persons to assess whether or not the purpose of Part 4 is

being met in accordance with s 53A.

We agree with ERANZ that the documentation of procurement practices and 5.23

related entity transactions should already be being compiled as a routine part of a

regulated supplier’s internal processes to demonstrate their compliance with the

provisions and intent of the Act.115 We expect under good governance practices,

suppliers would be expected to have these policies and existing documentation.

A submission from Asplundh on the problem definition paper noted that 5.24

contestable procurement processes can also support the development of local

markets for providing these same services to the community.116 Where the

opportunity exists for service providers to contest for service contracts, this

supports the development (or establishment) of operations that can not only

service the regulated supplier but also the wider community in a region.

In response to concerns from regulated suppliers around compliance costs in our 5.25

draft decision, we have reduced the prescriptiveness of the procurement policies

and processes disclosure in the ID determination.117

This disclosure is not required where a de minimis threshold is met, as summarised 5.26

in Table 5.2.

114 For example, Vector “Vector submission on the Review Related Party Transactions Review Draft Decision”

(27 September 2017), para 28. 115

ERANZ “Related party transactions – Invitation to contribute to problem definition” (17 May 2017),

para 4.5. 116

Asplundh “Input methodologies review - related party transactions - Invitation to contribute to problem

definition / initial findings” (17 May 2017). 117

Electricity Distribution Information Disclosure Amendments Determination 2017 [2017] NZCC 33, clauses

2.3.10–2.3.11, 2.3.12(1), (3), (5); Gas Distribution Information Disclosure Amendments Determination

(No.2) 2017 [2017] NZCC 34, clauses 2.3.10–2.3.11, 2.3.12(1), (3), (5); and Gas Transmission Information

Disclosure Amendments Determination (No.2) 2017 [2017] NZCC 35, clauses 2.3.10–2.3.11, 2.3.12(1), (3),

(5).

78

Practical application of procurement policies and processes

This disclosure requirement seeks to provide assurance to interested persons that 5.27

the procurement policies and processes are a true representation of what is being

consistently applied in practice in regards to related party transactions.

We would expect the description of practical application to include information 5.28

such as:

5.28.1 key criteria or technical standards under which the supplier acquires the

assets, goods or services;

5.28.2 for each of the supplier’s related parties used in the disclosure year, the

supplier’s reasons for using each related party;

5.28.3 how the costs of assets, goods or services for related party transactions is

set in practice; and

5.28.4 changes since the preceding disclosure year in how the supplier applies the

procurement policy.

In response to concerns around compliance costs in our draft decision, we have 5.29

reduced the prescriptiveness of the practical application of procurement policies

and processes disclosure in the ID determination.118 We have removed the

requirement in the ID determination to describe how directors of the regulated

supplier have decided whether or not the procurement policy has largely been

applied in practice.119

This disclosure is not required where a de minimis threshold is met as summarised 5.30

in Table 5.2.

118 Electricity Distribution Information Disclosure Amendments Determination 2017 [2017] NZCC 33,

clause 2.3.12(1), (3), (5); Gas Distribution Information Disclosure Amendments Determination (No.2) 2017

[2017] NZCC 34, clause 2.3.12(1), (3), (5); and Gas Transmission Information Disclosure Amendments

Determination (No.2) 2017 [2017] NZCC 35, clause 2.3.12(1), (3), (5). 119

This was also suggested by PwC in their submission on our draft decision; PwC in capacity as auditors

“Submission to the Commerce Commission on Input methodologies review: draft decision on related party

transactions” (27 September 2017), para 17.

79

Policies requiring the purchase of unregulated goods or services

A regulated supplier’s monopoly position in the regulated market could provide it 5.31

with the ability to leverage that market power into neighbouring markets by

requiring consumers of regulated services to purchase unregulated services from a

related party of the regulated supplier.

We consider that there is a possibility that policies tying the purchase of regulated 5.32

and unregulated services may damage the interests of consumers of regulated

services, by forcing them to pay more for complementary unregulated services

than they would if they were free to choose the supplier of unregulated services

with whom they wished to deal. In our view, providing greater transparency in

relation to such requirements would promote the long-term benefit of consumers

of regulated services; in particular, by constraining the ability of regulated suppliers

(through their related parties) to extract excessive profits.

A regulated supplier may have internal policies and procedures which contain these 5.33

kinds of requirements. For example, a regulated supplier may have a policy which

explicitly requires consumers to use its related party for vegetation management

services, where the responsibility for managing vegetation is the responsibility of

the consumer. Similarly, a regulated supplier may have a policy that requires

contractors constructing new connections to its network to comply with certain

standards, that in practice only its related party is able to comply with.

In order to reveal situations like this, in our draft decision we proposed requiring 5.34

the disclosure of policies or technical requirements under which a regulated

supplier referred customers to a related party in respect of goods or services

related to the regulated service.

In its submission on our draft decision, Vector considered that the requirement to 5.35

disclose policies or technical requirements when referring a customer to a related

party was “unconnected to the matters raised in the Commission’s problem

definition” for related party transactions and “deviates from its statutory mandate

under section 52A of the Act and could be considered beyond the limits of its

power under Part 4 of the Act.”120

120 Vector Limited “Vector Submission on the Review Related Party Transactions Review Draft Decision”

(27 September 2017), paras 23 and 25.

80

We acknowledge that our use of the word ‘referral’ in the draft determination may 5.36

have had the potential to be interpreted more expansively than we had

intended.121 Accordingly, we have amended the wording in the final ID amendment

determination to limit the application of the disclosure requirement to policies or

procedures that require or have the effect of requiring a consumer to purchase

assets or goods or services that are related to the regulated service from a related

party.

We note, however, that a regulated supplier may engage in other activities that 5.37

involve both regulated and unregulated services that do not necessarily involve a

requirement or an effective requirement to purchase unregulated goods or

services. Competition in markets for unregulated services, and consumers of

regulated services, may well be adversely affected by such activities that may not

involve a requirement per se but that nevertheless can be used to leverage the

regulated supplier’s market power.

Although policies that relate to such activities may not be required to be disclosed 5.38

under our ID rules, they may not comply with the provisions of Part 2 of the Act

(just as conduct that is in accordance with a policy or procedure that we require to

be disclosed may also not comply with Part 2 of the Act).

By requiring the disclosure of such policies and procedures, interested persons will 5.39

be provided with information which will allow them to better assess whether the

purpose of Part 4 is being met, consistent with the purpose of information

disclosure set out in s 53A of the Act.

Recent examples of market testing of transaction terms

We have included disclosure requirements that detail how and when the regulated 5.40

supplier last tested the arm’s-length terms of transactions (eg, by way of tendering,

benchmarking or other method) for at least one representative example

transaction.

If there are significant differences between how the current related party 5.41

procurement policy has been applied between expenditure categories, the

regulated supplier must provide separate representative example transactions that

demonstrate the differences.

121 Vector Limited “Vector Submission on the Review Related Party Transactions Review Draft Decision”

(27 September 2017), para 24.

81

This further disclosure will enable interested persons to assess whether the 5.42

efficiency dimensions of the regulatory objectives of Part 4 have been adversely

affected by a related party relationship and, in particular, whether the related party

transactions reflect prudent and efficient costs on arm’s-length terms.

The disclosure would also enable us to assess whether the related party 5.43

transactions are consistently based on a demonstrated and objective measure as

outlined in the policy intent. This will enable the Commission and other interested

persons to gain an understanding of whether the related party transactions values

entering the regulated supplier, for at least one representative example of market

testing, have been tested to ensure efficient input costs for the regulated service.

Submissions on our problem definition paper commented on the importance of 5.44

open and competitive tendering processes when procuring goods or services from

contestable markets.122 However, we also understand the flipside that unnecessary

external contracting can create inefficient transaction costs.123

We have chosen not to impose prescriptive requirements as to how the supplier of 5.45

the regulated service chooses to test the market. We have left testing methods to

the regulated supplier’s discretion and may be through benchmarking, open tender

process, market testing of transaction terms, or another preferred process that

sufficiently satisfies the auditor.

We consider this to be a low-cost approach as this should be information which the 5.46

regulated supplier already has on record. Detailed disclosures will require regulated

suppliers to assess how and when it last tested the market by reference to at least

one representative example, which should limit the collation effort required by the

regulated supplier.

In response to concerns around compliance costs arising from our draft decision, 5.47

we have removed the requirement to provide a representative example for each

opex and capex category. Instead we are requiring a representative example for

each method of market testing.124

122 ERANZ “Related party transactions – Invitation to contribute to problem definition” (17 May 2017),

para 4.6. 123

As submitted by Vector “Submission on related party transactions invitation to contribute to problem

definition” (17 May 2017), para 10. 124


2.3.12(4); Gas Distribution Information Disclosure Amendments Determination (No.2) 2017 [2017] NZCC

82


in Table 5.2.

Map of anticipated network expenditure and network constraints

We consider that if a regulated supplier has the potential for undertaking related 5.49

party transactions in respect of potential projects identified in its AMP, then future

opex and capex projects with related parties should be disclosed on a map of

anticipated network expenditure and network constraints.

We consider this disclosure requirement has the potential to support suppliers of 5.50

the regulated service by enabling third party providers to suggest cost-effective

(and potentially non-network) solutions. This disclosure requirement is intended to

provide confidence that input costs of the regulated service are efficient.125

With new technology developments happening rapidly in the energy distribution 5.51

sectors, an easily accessible disclosure of network projects and network constraints

would also enable the supplier of the regulated service to identify potential

alternative solutions.

Similar disclosures are provided in most AMPs. However, we consider that an 5.52

additional simplified high level summary of such information, particularly where

related parties have been or may be engaged to carry out the work, would better

enable interested persons to quickly identify potential opportunities to offer new

services. If that provision is more efficient, consumers could benefit.

34, clause 2.3.12(4); and Gas Transmission Information Disclosure Amendments Determination (No.2) 2017

[2017] NZCC 35, clause 2.3.12(4). 125

That is, the price charged to consumers is based on efficient input costs and the presence of related party

transactions does not result in inflated prices to consumers. This is outlined further in Table 2.1 of this

paper.

83

Submissions on our draft decision considered that a map of anticipated network 5.53

expenditure and network constraints, as described above, was not solely a related

parties issue, and that therefore, the imposition of any such disclosure

requirements was not within the permissible scope of our problem definition. For

example, PwC commented that:126

The proposal to require asset management information about network constraints and

future network investment is not necessary to provide transparency about related

party transactions. This is a wider asset management issue which is not confined to

those with related party service providers. These additional disclosures should not be

included in this decision because they fall outside the scope of the problem being

addressed.

We accept that this requirement could be seen as a wider asset management issue 5.54

and therefore could be extended to apply to all regulated suppliers, regardless of

whether they transact with related parties. We also acknowledge that it may have

been possible to interpret our draft decision as being aimed at the disclosure of

information that is related to regulated suppliers more generally. More specifically,

our draft decision required the disclosure of information if the regulated supplier

had any related parties, but the information required to be disclosed itself did not

specifically relate to related parties.

The final ID amendments determination requires regulated suppliers to disclose, 5.55

for each item of future opex or capex required to be included on the map, whether

the future opex or capex is:

5.55.1 already contracted with a supplier and, if so, whether it is with a related

party;

5.55.2 forecast to require the supply of assets, goods or services by a related

party; or

5.55.3 currently not projected for supply by a related party.

126 PwC “Submission to the Commerce Commission on Input methodologies review: draft decision on related

party transactions” (27 September 2017), para 13.

84

We note that Energy Networks Australia has developed a network opportunities 5.56

map to provide transparent and up-to-date information that can address network

capacity constraints and reduce costs to consumers.127


in Table 5.2.

Related party loan disclosures

In response to our draft decision, Vector submitted that the Commission should 5.58

consider inter-company loan disclosure as part of the related party rules:128

If the Commission is minded to consider amendments to the RPT rules based on

deriving a public benefit irrespective of whether the benefit is related to the Part 4

purpose, then it should consider creating greater transparency around related party

inter-company loans. We believe there is a public benefit from having greater

transparency around related party inter-company loans among suppliers.

The current Part 4 regime assumes a fixed notional level of leverage of 42% for 5.59

EDBs and gas pipeline businesses, and the ID requirements do not require

disclosures of loans to or by companies regulated under Part 4. This is irrespective

of whether the loans are to or from related party providers or arms-length

providers.

We acknowledge there are potential risks to consumers if regulated suppliers use 5.60

excess levels of debt to fund their investments in opex or capex, as this could

constrain the suppliers’ ability to invest efficiently in their networks. However, it is

not evident why we should single out related party loans for disclosure as opposed

to requiring more general disclosure of the ability of suppliers to invest in their

networks, including their debt levels. Therefore, we have not extended the

disclosure requirements to cover inter-company or other lending to or from related

parties.

127 The map and subsequent information on the opportunities map can be found at:

http://www.energynetworks.com.au/network-opportunity-maps. 128

Vector “Vector submission on the Review Related Party Transactions Review Draft Decision”

(27 September 2017), paras 36–37.

http://www.energynetworks.com.au/network-opportunity-maps

85

Attachment A Guidance for the interpretation of paragraphs (a) and (b) of the ‘related party’ definition

Purpose of this attachment

A1 This attachment is intended to provide guidance to suppliers and other stakeholders on the interpretation of the two paragraphs of the ‘related party’ definition.

A2 Figure A1 outlines scenarios where the related party rules and cost allocation rules could apply. In these examples the scenarios refer to a regulated supplier and the regulated service that it provides. The scenarios are:

A2.1 No related party valuation/No cost allocation: no related party is used by the regulated supplier to supply services, goods or assets to the regulated service and all transaction costs charged from the unrelated third party to the regulated service are identified as being directly attributable to the regulated service. All charges from the unrelated third party are disclosed at cost and the regulated supplier derives no margin on those costs other than in the regulated service.

A2.2 No related party valuation/Cost allocation applies: no related party is used by the regulated supplier to supply services, goods or assets to the regulated service, and the transaction costs charged from the unrelated third party apply to both the regulated service and unregulated services provided by the regulated supplier. All charges from the unrelated third party to the regulated service are disclosed at cost and the regulated supplier derives no margin on those costs other than in the regulated service.

A2.3 Related party valuation paragraph (a) applies/No cost allocation: services, goods or assets are provided to the regulated service by both a related party company (ie, paragraph (a) applies) and by an unrelated third party. All transaction costs charged from the related party company and the unrelated third party to the regulated service are identified as being directly attributable to the regulated service.

A2.4 Related party valuation paragraph (a) applies/Cost allocation applies: services, goods or assets are provided to the regulated service by both a related party company (ie, paragraph (a) applies) and by an unrelated third party. The transaction costs charged from the related party company and the unrelated third party apply to both the regulated service and unregulated services provided by the regulated supplier.

86

A2.5 Related party valuation paragraph (b) applies/No cost allocation: services, goods or assets are provided to the regulated service by both a related party part of the regulated supplier (ie, paragraph (b) applies) and by an unrelated third party. The related party part also supplies services, goods or assets to unrelated external parties. All transaction costs charged from the related party part and the unrelated third party to the regulated service are identified as being directly attributable to the regulated service.

A2.6 Related party valuation paragraph (b) applies/Cost allocation applies: services, goods or assets are provided to the regulated supplier by both a related party part of the regulated supplier (ie, paragraph (b) applies) and by an unrelated third party. The related party part also supplies services, goods or assets to unrelated external parties. The transaction costs charged from the related party part and the unrelated third party apply to both the regulated service and unregulated services provided by the regulated supplier.

87

Figure A1: Related party rules and cost allocation scenarios

88

89

90

91

Attachment B Indicative examples of arm’s-length and non-arm’s-length transactions


B1 This attachment is intended to provide guidance to suppliers and other stakeholders on how a related party transaction may (or may not) meet the general valuation rule.

B2 This is not intended to replace the valuation methodology, and is only intended to support the application of the general valuation rule in the body of the IM and ID determinations.129

129 See: Electricity Distribution Services Input Methodologies Amendments Determination 2017 [2017] NZCC

30, clauses 2.2.11(1)(g), 2.2.11(5), 5.3.11(1)(g) and 5.3.11(7); Gas Distribution Services Input

Methodologies Amendments Determination 2017 [2017] NZCC 31, clauses 2.2.11(1)(g), 2.2.11(5),

5.3.11(1)(g) and 5.3.11(7); Gas Transmission Services Input Methodologies Amendments Determination

2017 [2017] NZCC 32, clauses 2.2.11(1)(g), 2.2.11(5), 5.3.11(1)(g) and 5.3.11(7); Electricity Distribution

Information Disclosure Amendments Determination 2017 [2017] NZCC 33, clause 2.3.6; Gas Distribution

Information Disclosure Amendments Determination (No.2) 2017 [2017] NZCC 34, clause 2.3.6; and Gas

Transmission Information Disclosure Amendments Determination (No.2) 2017 [2017] NZCC 35, clause

2.3.6.

92

Examples of related party transactions which would and would not be considered on

arm’s-length terms

B3 Table B1 provides a list of indicative transactions on arm’s-length terms to support regulated suppliers with their understanding of the valuation methodology.

Non-exhaustive list of examples of arm’s-length transactions Table B1

Method Brief description

Open tendering

process

Regulated supplier follows an open tendering process with the following indicative

attributes to determine the arm’s-length terms:

i. all relevant terms are accessible by third parties prior to providing a tender;

ii. the regulated supplier assesses all tenders which are equally the most

advantageous to the supplier of the regulated service; and

iii. in considering the term of the contracts of services, the regulated supplier

considers the industry best practice for that service and the materiality of the

service.

Comparable

pricing

Regulated supplier uses comparable pricing with the following indicative attributes to

determine the arm’s-length terms when majority of its related party’s sales are to third

parties:

i. third parties may purchase the same or substantially similar assets from the

related party on substantially the same terms, including price; or

ii. over time that price is substantially the same as the price paid for substantially

similar assets or services from a party other than a related party.

Independent

market

valuation

Recorded at its market value as at the date of acquisition as determined by an independent

valuation.

B4 Table B2 provides a non-exhaustive list of examples of transactions which on their own would not meet the arm’s-length requirement or would not demonstrate the valuation is based on an objective and independent measure.

B5 We note that depending on the individual situation, auditors may be able to complete additional testing to verify that such methods meet the requirements of the general valuation rule.

93

Non-exhaustive list of examples of non-arm’s-length transactions Table B2

Method Brief description

Internal sign off Where the director or internal manager of the supplier of the regulated service has

verified the transaction as arm’s-length without ensuring that there has been

consideration for the open market. This would not demonstrate objective and

independent measurement.

Long-term

contracts with no

review period or

termination

provisions

The supplier of the regulated service enters into long-term contracts with no considered

review period. Such transactions could become out of date with current market

practices and prices.

We note that contracts with longer terms can be important to underpin large

investments by suppliers and promote competition. However, the appropriate contract

length will depend on the type of asset or service being provided.

No documented

procurement

policy in place

Without a clear procurement policy, on its own, it may be more difficult for the auditor

to assess that the arm’s-length principle would be met.

Indicative worked examples

B6 The following are indicative worked examples which show how related party transactions could meet the general valuation rule:

B6.1 The Big City Lines Limited (BCLL) situation, where there is clear opportunity to benchmark against an existing arm’s-length contractor.

B6.2 The Regional Lines division situation, where there is an imperfect regional market for contracting services and a greater depth of audit scrutiny might be expected.

Example 1: Big City Lines Limited’s situation

B7 BCLL provides electricity lines services to a large region of 250,000 consumers and owns related party Big City Vegetation Limited, which provides vegetation management services to BCLL.

B8 BCLL requires $150,000 of vegetation management work over the next year and would like Big City Vegetation Limited to undertake most of the work.

B9 For vegetation management services, approximately 60% of this work is completed by Big City Vegetation Limited. The remainder is completed by an independent third party contractor that operates in the region. BCLL is able to observe the third party contracting price so can benchmark procurements from the related party against this price.

94

B10 The independent auditor must assess whether BCLL is able to demonstrate compliance with the general valuation rule. The auditor is able to cite sufficient evidence to test that BCLL procures the services from Big City Vegetation Limited at terms consistent with those provided by the other third party contractor. On that basis, the auditor is likely to have enough information to be able to form the assurance opinion.

Example 2: Regional Lines’ division situation

B11 Regional Lines provides electricity lines services to a regional town of 40,000 consumers and operates related party Regional Lines Engineering, which is a division of Regional Lines. Regional Lines Engineering provides electrical engineering services for Regional Lines’ lines service and other EDBs in nearby regions.

B12 There are currently no other electrical engineering providers in the region of sufficient scale to carry out the work that Regional Lines requires.

B13 Regional Lines requires electrical engineering services, and has engaged its division Regional Lines Engineering to complete the work.

B14 Regional Lines uses an external consultancy company to complete benchmarking services to determine the permissible price that can be charged to Regional Lines Engineering for electrical engineering services. As Regional Lines Engineering is the only available electrical engineering service provider in the region capable of carrying out the work, Regional Lines compares the prices charged by Regional Lines Engineering with the benchmarking completed by the external consultancy.

B15 The independent auditor must assess whether Regional Lines is able to demonstrate compliance with the general valuation rule. The auditor is able to cite sufficient evidence to test that Regional Lines procures the services from Regional Lines Contracting at terms consistent with those provided by the external consultancy company. On that basis, the auditor is likely to have enough information to be able to form the assurance opinion.

95

Attachment C Relationship between cost allocation rules and the related party transactions provisions


C1 This attachment provides guidance on how the amended related party transactions rules work with the cost allocation rules under common input cost scenarios. This guidance does not form part of the ID determination and is provided to help with application of the ID requirements.

96

Figure C1: Related Party transactions and cost allocation

97

Attachment D Incorporation of auditing and accounting standards by reference into determinations


D1 This attachment provides an overview of how we have incorporated relevant auditing and accounting standards into the IM and ID determinations by reference in accordance with the applicable drafting rules set out in Schedule 5 of the Act.

Incorporation by reference process

D2 To provide greater alignment and minimise interpretation issues, we have incorporated relevant auditing and accounting standards into the IM and ID determinations.

D3 We have incorporated International Standard on Assurance Engagements (New Zealand) 3000, Assurance Engagements Other than Audits or Reviews of Historical Financial Information, Standard on Assurance Engagements 3100 – Compliance Engagements into the relevant ID Determinations and part of the definition of ‘related party’ from New Zealand Equivalent to International Accounting Standard 24, Related Party Disclosures (NZ IAS 24) (auditing and accounting standards) into the relevant IM Determinations by reference in accordance with the process set out in Schedule 5 of the Act in order to provide:

D3.1 greater clarity around the requirements for the review of related party transactions in the ID independent audit assurance engagement; and

D3.2 greater consistency between our determinations and the auditing and accounting standards.

D4 In our draft decision, we proposed the incorporation by reference of International Standard on Auditing (New Zealand) 550, Related Parties, as well as a number of other standards. However, our final decision is to only incorporate by reference the standards listed above, as a result of a submission on our proposed incorporation by reference in our draft decision.130


draft decision on related party transactions” (27 September 2017), paras 24-30.

98

D5 Schedule 5 of the Act sets out the process for incorporating material by reference into a determination made under s 52P or into an input methodology made under s 52W. We have incorporated material by reference into:

D5.1 the ID determinations;131 and

D5.2 the IM determinations.132

D6 The Act allows us to incorporate material by reference into a determination or input methodology if:

D6.1 the material deals with technical matters; and

D6.2 it is impractical to include it in or publish it as part of, the determination or input methodology.133

D7 We consider that the auditing and accounting standards are technical in nature because they deal with technical accounting and auditing matters. We also consider that it would be impractical to include the auditing or accounting standards in the determinations themselves due to the length of the auditing and accounting standards.

D8 The auditing and accounting standards must be incorporated into the determinations as they exist at the time the determinations are published and have legal effect as part of the determinations.134

D9 Accordingly, we have incorporated the following standards into the ID Determinations:

D9.1 International Standard on Assurance Engagements (New Zealand) 3000, Assurance Engagements Other than Audits or Reviews of Historical Financial Information, issued by the New Zealand Auditing and Assurance Standards Board of the External Reporting Board in July 2014; and

D9.2 Standard on Assurance Engagements 3100 – Compliance Engagements issued by the External Reporting Board in October 2014 and incorporating amendments up to August 2014.

D10 We have also incorporated part of the definition of ‘related party’ from New Zealand Equivalent to International Accounting Standard 24, Related Party Disclosures (NZ IAS 24) issued by the New Zealand Accounting Standards Board of the External

131 Made under s 52P of the Act.

132 Made under s 52Y of the Act.

133 Clause 2 of Schedule 5 to the Act.

134 Clause 2(3) of Schedule 5 of the Act.

99

Reporting Board in November 2009, incorporating amendments to 31 December 2015 into the IM Determinations.

D11 Later amendments to or replacements of the auditing and accounting standards are not automatically incorporated into, and have legal effect as part of, the determinations. This will only occur if a subsequent determination or input methodology states that the amendment or replacement has legal effect as part of the determination or input methodology, or the Chairperson of the Commission adopts the amendment or replacement as having legal effect by notice in the Gazette.135

D12 The amendment or replacement must also be made by the person or organisation that made the original material and must be of the same general character as the original material.

D13 Our intention is to adopt any amendments or replacements to the auditing and accounting standards to the extent they are consistent with our related party provisions policy intent and have legal effect as part of the determinations. This will ensure that the requirements in our determinations reflect the most up-to-date auditing and accounting standards.

135 Clause 5 of Schedule 5 of the Act.

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